Nuvo Pharmaceuticals, Inc.
Annual Report 2017

Plain-text annual report

Dear Nuvo Shareholders, With 2017 behind us, we now have time to reflect on a year of challenges, as well as our many positives and opportunities for growth in 2018. As many of you know, Nuvo’s U.S. Pennsaid® 2% revenue is generated by commercial bottle and physician sample sales from our Varennes, Québec manufacturing facility to our U.S. distribution partner Horizon Pharma plc (Horizon). Nuvo records revenue upon product shipments to Horizon. Horizon’s orders are significantly influenced by Pennsaid 2% U.S. prescription trends. U.S. prescriptions for Pennsaid 2% stabilized through the year, despite the changes Horizon made to its primary care business commercial strategy. Total prescriptions for 2017 were 434,000 compared to 457,000 in 2016. Horizon’s U.S. Pennsaid 2% business faced increased managed care challenges, which lead to portfolio-wide changes in their inventory management, a modest reduction in the number of sales representatives and an approximately 50% decrease in their physician sample purchases – a change that will impact our sample production in 2018 and possibly beyond. In 2017, these factors, together with a planned shutdown of our Varennes manufacturing facility to install new “serialization” equipment driven by the implementation of new U.S. Food and Drug Administration (FDA) regulations, resulted in Horizon drawing down its existing commercial bottle and product sample inventories at the expense of new production orders to Nuvo. Despite its commercial strategy changes, Horizon continues to actively support the Pennsaid 2% business with an approximately 250 representative national sales force. Pennsaid 2% remains the number two revenue generating product in Horizon’s overall portfolio and the number one product in its primary care portfolio. The bottom line is that Pennsaid 2% remains a very important product for Horizon and an important source of revenue for Horizon and for Nuvo. In 2017, we announced two new international Pennsaid 2% partners: Sayre Therapeutics (Sayre) in India and Gebro Pharma (Gebro) in Switzerland. In December Sayre submitted their Pennsaid 2% registration dossier in India and anticipate an approximate 12-month review window with the Drug Controller General of India, the Indian regulatory approval organization. Gebro anticipates meeting with Swissmedic, the Swiss regulatory approval organization, towards the end of Q2 or early Q3 2018 for scientific advice regarding an application for Swiss regulatory approval. We are very pleased with the progress Sayre and Gebro are making and will update shareholders as our partners proceed through their respective regulatory processes. Furthermore, we continue to believe that the global Pennsaid 2% opportunity is very attractive and anticipate completing additional licensing deals in 2018. Despite the challenges we faced in 2017, which were out of our control, Nuvo maintained a profitable business throughout the year on a trailing-twelve months basis and we continue to operate debt free and with significant cash on our balance sheet. In May, we announced the successful outcome of Horizon’s patent litigation against the generic company, Actavis Laboratories UT, Inc. (Actavis), which involved the challenge of one of Horizon’s U.S. Pennsaid 2% patents. The judge’s decision upheld the validity of the patent and subject to appeal, secured this revenue stream for Nuvo until the patent’s expiration in 2027. It is important to note that there are 18 additional issued patents in the FDA Orange Book that protect the U.S. Pennsaid 2% franchise that were not the subject of this litigation - the longest of which extends to 2030. This was a major victory for Horizon and Nuvo and is evidence of the exceptional Pennsaid 2% patents that were developed by the Nuvo team. Identical and/or similar patents have been issued throughout key ex-U.S. jurisdictions, a notable product attribute that supports our Pennsaid 2% out-licensing efforts worldwide. In August, we secured a $6.0 million operating loan facility with the Royal Bank of Canada (RBC) (Facility). The Facility can be accessed by Canadian dollar denominated loans and U.S. dollar denominated loans that will bear interest at a low, single-digit premium to RBC's Prime Rate or RBC's U.S. Base Rate. While we have not yet drawn any amounts under the Facility, it gives us the flexibility to deploy our existing cash toward product and business acquisitions that meet our criteria. On November 28, 2017, Nuvo's common shares commenced trading on the OTCQX® market in the United States. This listing provides Nuvo shareholders in the U.S. with simplified access to trade Nuvo shares, with no material increase in our public company costs. Towards the end of the year, we incorporated Nuvo Pharmaceuticals (Ireland) Limited (Nuvo Ireland). Historically Nuvo has had an E.U. affiliate in the U.K. which held our E.U. marketing authorizations for Pennsaid. However, the decision by the U.K. to exit the E.U. common market (Brexit) required us to make changes to our E.U. business structure to remain in compliance with E.U. regulations. This wholly owned subsidiary of Nuvo Pharmaceuticals Inc. was established to be the future operational hub for Nuvo’s ex- Canadian business and to hold our E.U. marketing authorizations within an E.U. member state. In November, we received Toronto Stock Exchange approval to proceed with a normal course issuer bid (NCIB) that allows us to use our existing cash to buy back Nuvo common shares. We believe that Nuvo shares are currently undervalued. The NCIB gives us the opportunity to strategically acquire shares for cancellation at an advantageous price with a view to increasing the value of the remaining shares outstanding. As the year came to a close, we were excited to announce we had completed the acquisition of the Resultz® ex-U.S. royalty stream, along with all intellectual property and product rights from Piedmont Pharmaceuticals LLC (Piedmont). Resultz is a best in class, non-pesticide treatment for head lice infestation in humans with over one million treatments sold annually outside of the U.S. The product’s five-minute treatment claim and 100% efficacy when used as directed differentiates it in the global head lice market. This transaction marked a significant new product acquisition for Nuvo Pharmaceuticals Inc. and demonstrates our commitment to grow and diversify our product portfolio and revenue streams. Resultz was an ideal acquisition for Nuvo, as it met all our product acquisition criteria. Namely, Resultz is currently generating revenue via a US$1.5 million annual royalty stream from the net sales of Resultz in select international markets by Reckitt Benckiser and other licensees, Resultz is approved throughout the E.U. and therefore ready for commercialization once we have suitable commercial partners in place for markets not currently partnered, Resultz is protected by patents into 2023, and most importantly, it is a product that we can produce at our manufacturing facility. On closing of this transaction, we paid US$7.0 million upfront from cash on hand. Nuvo will also pay to Piedmont, the original developer of Resultz, a low single digit royalty on net sales in new territories, as well as certain sales-based milestones. We will incur some one-time closing and transition expenses in 2018, but these should taper off in the second half of the year. We quickly followed the ex-U.S. Resultz acquisition with the acquisition of the U.S. rights to Resultz in January 2018. On closing of the U.S. acquisition, we paid US$1.5 million to Piedmont and will pay a single- digit royalty on net sales through 2034. Resultz was cleared by the FDA for marketing in May 2017, but has yet to be commercially launched. After these two transactions, Nuvo now owns the global product and intellectual property rights to Resultz, a best in class head lice treatment. To date, Resultz has been commercialized in 11 countries where it has been a very successful product achieving market share of anywhere between 15-35%. We believe that with its category leading 5-minute treatment and 100% efficacy, we are well positioned to partner Resultz in many new markets. Our number one priority is to enter the U.S. market, which has an annual retail value of approximately US$250 million, along with key markets in the E.U. such as Germany and Italy. The combined annual retail value of the unpartnered E.U. and U.S. head-lice markets are approximately US$400 million. Most importantly, the U.S. market is dominated by ineffective and dangerous pesticide-based treatments which presents a very timely and potentially lucrative opportunity for our highly effective and safe product. Another key priority for Nuvo in 2018 is our continued progress towards an E.U. regulatory submission for Pennsaid 2%. We had previously indicated that Nuvo would be presenting a new “meta-analysis” of existing Pennsaid data to select E.U. regulatory authorities at meetings to be held towards the end of Q1 2018. These meetings have been arranged and we anticipate providing a further update to our E.U. registration strategy during Q2 2018. Our strategy is to present clinical data relating to the safe and effective use of Pennsaid 2% for osteoarthritis, an indication that is aligned with our approved labelling in the U.S. for Pennsaid 2%, and the approved labelling for Pennsaid in the E.U. and Canada. The global market for topical diclofenac (the active ingredient in Pennsaid 2%) is sizeable, with sales of approximately $1.0 billion annually outside of the U.S. This is a market we want to access and we are working diligently to make this a reality. Business development will remain a key focus for Nuvo in 2018. We have high expectations for our Resultz and Pennsaid 2% partnering activities in 2018 and anticipate announcing new collaborations throughout the year. We continue to seek new product and business acquisition opportunities. Finding product acquisition opportunities is relatively straightforward, but finding the right products at the right price is much more challenging. We approach business development with not only financial discipline, but also with consideration for commercial, scientific and legal synergies and future growth opportunities. As a company that will be relying on business development for pipeline and portfolio growth, we are committed to making the right deals for the right products and businesses at the right price. We appreciate the continued support of our shareholders and look forward to continuing to execute on our growth plans to enhance shareholder value. I would also like to thank all Nuvo employees and our Board of Directors for their hard work and support over the past year. Sincerely, Jesse Ledger President & CEO Nuvo Pharmaceuticals Inc. Management’s Discussion and Analysis (MD&A) March 22, 2018 / The following information should be read in conjunction with the Nuvo Pharmaceuticals™ Inc. (Nuvo or the Company) Consolidated Financial Statements for the year ended December 31, 2017 which were prepared in accordance with International Financial Reporting Standards (IFRS). Additional information about the Company, including the Consolidated Financial Statements and Annual Information Form (AIF), can be found on SEDAR at www.sedar.com. All amounts in the MD&A, the Consolidated Financial Statements and related Notes are expressed in Canadian dollars, unless otherwise noted. Forward-looking Statements This MD&A contains “forward-looking statements” within the meaning of applicable securities laws. Forward-looking statements can be identified by words such as: “anticipate,” “intend,” “plan,” “goal,” “seek,” “believe,” “project,” “estimate,” “expect,” “strategy,” “future,” “likely,” “may,” “should,” “will” and similar references to future periods. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on the Company’s current beliefs, expectations and assumptions regarding the future of its business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of the Company’s control. Nuvo’s actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, readers should not rely on any of these forward-looking statements. Important factors that could cause Nuvo’s actual results and financial condition to differ materially from those indicated in the forward- looking statements include, among others, the risk factors included in Nuvo’s most recent Annual Information Form dated March 22, 2018 under the heading “Risks Factors”, and as described from time to time in the reports and disclosure documents filed by Nuvo with Canadian securities regulatory agencies and commissions. These and other factors should be considered carefully and readers should not place undue reliance on Nuvo’s forward-looking statements. As a result of the foregoing and other factors, no assurance can be given as to any such future results, levels of activity or achievements and none of Nuvo or any other person assumes responsibility for the accuracy and completeness of these forward-looking statements. Any forward-looking statement made by the Company in this MD&A is based only on information currently available to it and speaks only as of the date on which it is made. Except as required by applicable securities laws, Nuvo undertakes no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise. Overview Nuvo is a publicly traded, global, commercial healthcare company with a portfolio of commercial products and pharmaceutical manufacturing capabilities. Nuvo has four commercial products that are available in a number of countries: Pennsaid® 2%, Pennsaid, Resultz® and the heated lidocaine/tetracaine patch (HLT Patch). Nuvo manufactures Pennsaid 2% for the U.S. market, Pennsaid for the global market and the bulk drug product for the HLT Patch at its U.S. Food and Drug Administration (FDA), Health Canada and E.U. approved manufacturing facility in Varennes, Québec. As at December 31, 2017, the Company employed a total of 49 full-time employees at its manufacturing facility in Varennes, Québec and its head office in Mississauga, Ontario. Corporate Reorganization On March 1, 2016, the Company completed a transaction (the Reorganization) pursuant to which Nuvo was reorganized into two separate, publicly traded companies, the Company and Crescita Therapeutics Inc. (Crescita). Detailed information regarding the Reorganization and its effects, including a description of certain risks and uncertainties in respect of the Reorganization and the operation of the Company and Crescita as separate, publicly traded companies, are included in the Nuvo Reorganization Circular that is available under the Company’s profile at www.sedar.com. Prior to the Reorganization, Nuvo operated two distinct business units: Nuvo and Crescita. Nuvo is a commercial healthcare company with a portfolio of commercial products and pharmaceutical manufacturing capabilities. Prior to the Reorganization, Crescita was a drug development business. The information presented herein reflects the completion of the Reorganization, with Crescita presented as discontinued operations. Growth Strategy The Company’s focus, in the short-term, is to continue to maximize the value of Pennsaid 2% and Resultz through out-licensing to commercial partners in international markets, identifying new opportunities to acquire additional, accretive, late-stage products or businesses to further diversify the Company’s existing product portfolio and revenue streams, and to better utilize the Company’s manufacturing facility in Varennes, Québec. Significant Transactions 2017 Acquisition of Global, ex-U.S. Rights to Resultz In December 2017, the Company acquired the global, ex-U.S. product and intellectual property rights to Resultz (50% isopropyl myristate, 50% cyclomethicone D5 topical solution lice and egg removal kit) from Piedmont Pharmaceuticals LLC (Piedmont). The transaction included existing royalty streams in France, Spain, Portugal, Belgium, Ireland and the United Kingdom, Canada, Russia, Australia and Israel (collectively the Royalty Markets), generated from a network of existing global licensees and license agreements that were assumed by Nuvo. Current global licensees include Reckitt Benckiser Group PLC, Aralez Pharmaceuticals Inc., Lapidot Medical and Takeda Belgium. Resultz is also pending registration in Japan, where the local license is held by Sato Pharmaceutical Co. Ltd. Resultz is protected by a portfolio of 40 issued patents globally. Resultz is currently approved for sale under its European Conformity (CE) mark as a class 1 medical device, but not yet partnered or generating revenue in all remaining E.U. territories. Under the terms of the agreement, Nuvo paid US$7.0 million ($8.8 million) on close to Piedmont. The transaction also included a single-digit royalty payable by Nuvo on net sales generated from non- Royalty Markets through 2023 and potential added future consideration in the form of payments for achieving certain aggregate annual net sales-based milestones. The accounting details are disclosed in Note 4, “Acquisition of Resultz Product and Intellectual Property Rights” of the Company’s Consolidated Financial Statements for the year ended December 31, 2017. Pennsaid 2% Out-licensing In December 2017, the Company entered into a license and distribution agreement with Gebro Pharma AG (Gebro Pharma) for the exclusive right to register, distribute, market and sell Pennsaid 2% in Switzerland and Liechtenstein. The Company is eligible to receive milestone payments and royalties on net sales of Pennsaid 2% in Switzerland and Liechtenstein and will earn product revenue from Gebro Pharma pursuant to an exclusive supply agreement from its manufacturing facility in Varennes, Québec. In March 2017, the Company entered into an exclusive license agreement with Sayre Therapeutics PVT Ltd. (Sayre Therapeutics) to distribute, market and sell Pennsaid 2% in India, Sri Lanka, Bangladesh and Nepal (the Territory). Nuvo received an upfront payment and is eligible to receive milestone payments and a double-digit royalty on net sales. Nuvo will supply Pennsaid 2% to Sayre Therapeutics on an exclusive basis from its manufacturing facility. 2016 Corporate Reorganization On March 1, 2016, Nuvo completed a corporate reorganization that reorganized Nuvo into two separate publicly traded companies: Nuvo and Crescita. See “Corporate Reorganization” and the Nuvo Reorganization Circular filed on SEDAR for information on this transaction. Pennsaid 2% U.S. Supply Agreement In connection with the October 2014 Pennsaid 2% U.S. Sale Agreement, the Company also entered into a long- term supply agreement with Horizon. Pursuant to the supply agreement, the Company agreed to supply Pennsaid 2% to Horizon from its Varennes, Québec manufacturing facility for commercialization in the U.S. The initial term of the supply agreement would have expired on December 31, 2022 and, unless terminated, would have automatically renewed for successive two-year terms, thereafter. In February 2016, the supply agreement was amended (Amended Supply Agreement) to extend the term of the agreement to December 31, 2029 and to introduce volume tiered pricing. The transfer price is subject to semi-annual adjustments based on Nuvo’s raw material costs and annual adjustments based upon changes in a national manufacturing cost index for pharmaceutical products. The supply agreement may be terminated earlier by either party for any uncured material breach or other customary conditions. Under the Amended Supply Agreement, Nuvo is obligated to supply Pennsaid 2% to Horizon and Horizon is obligated to obtain all of its requirements for Pennsaid 2% from Nuvo, subject to Horizon being able to obtain up to 10% of its requirements from a third-party alternative supplier of Pennsaid 2%. Specifically, the supply agreement as amended provides for the selection and qualification of an alternate supplier of Pennsaid 2% and an alternative supplier of the active pharmaceutical ingredient (API). Following the approval by the FDA of a selected alternate supplier, and subject to certain limitations, the Company is required to enter into a supply agreement with the alternate supplier with respect to Pennsaid 2% or its API. To the extent that maintaining regulatory approvals for an alternative supplier requires the Company to purchase minimum quantities of drug product or API from the alternate supplier, the Company is obligated to purchase such minimum quantities, subject to Horizon’s obligation to reimburse the Company for any excess cost compared to the cost to otherwise obtain such drug product or API. To-date, a third-party alternative supplier of Pennsaid 2% has not been qualified to manufacture the product. Key Developments During the three months ended December 31, 2017, and up to the date of this MD&A: • • • • • According to IMS Health, for the year ended December 31, 2017, U.S. prescriptions of Pennsaid 2% were 434,000 compared to 457,000 for the year ended December 31, 2016. U.S. prescriptions of Pennsaid 2% were 110,000 in the fourth quarter of 2017 compared to 108,000 prescriptions in the third quarter of 2017; In January 2018, the Company’s wholly owned subsidiary, Nuvo Pharmaceuticals (Ireland) Limited (Nuvo Ireland) acquired the U.S. rights to Resultz from Piedmont. The acquisition included all U.S. product and intellectual property rights. Resultz was cleared as a Class 1 medical device by the FDA in May 2017 and has not yet been commercially launched in the U.S. Nuvo anticipates commercializing Resultz in the U.S. through a licensing partner and has already initiated discussions with potential licensees. Under the terms of the agreement, US$1.5 million ($1.9 million) was paid to Piedmont. The transaction includes a single-digit royalty payable by Nuvo Ireland on net sales through 2034. Nuvo, through its Nuvo Ireland subsidiary, has also obtained a right of first refusal to license or acquire certain related assets from Piedmont targeting other human indications; In December 2017, the Company acquired the global, ex-U.S. product and intellectual property rights to Resultz from Piedmont (See “Significant Transactions - Acquisition of Global, ex-U.S. Rights to Resultz”); In December 2017, the Company entered into a license and distribution agreement with Gebro Pharma for the exclusive right to register, distribute, market and sell Pennsaid 2% in Switzerland and Liechtenstein (See “Significant Transactions - Pennsaid 2% Out-licensing”); In November 2017, the Company announced that the Toronto Stock Exchange (TSX) had approved its notice of intention to make a normal course issuer bid for a portion of its outstanding common shares as appropriate opportunities arise from time-to-time. Pursuant to the notice, Nuvo is authorized to acquire up to a maximum of 919,819 of its common shares, or approximately 10% of the public float of 9,198,191 as of November 30, 2017, for cancellation over the next 12 months. Nuvo believes that the repurchase of a portion of outstanding common shares is an appropriate use of available cash and is in the best interest of Nuvo and its shareholders; • On November 28, 2017, the Company's common shares commenced trading on the OTCQX® market in the United States under the symbol "NRIFF". Nuvo's common shares will continue to trade on the Toronto Stock Exchange under the symbol "NRI"; and • In November 2017, the Board of Directors of the Company appointed Jesse Ledger to the position of President & Chief Executive Officer. Mr. Ledger had previously held the position of President. Mr. Ledger assumed the CEO role from John London who was appointed the Company's Executive Chairman and continues to serve on its board of directors. Commercial Products Resultz Resultz is a commercial-stage, over-the-counter (OTC) product intended to kill head lice and remove their eggs from hair with as little as a 5-minute treatment. It is a pesticide-free, topical solution that contains only two common cosmetic ingredients - 50% isopropyl myristate and 50% cyclomethicone D5. It is clinically proven to achieve 100% effectiveness when used as directed. The following table summarizes where the Company’s partners have commercialized Resultz or are working to obtain regulatory approval: Brand Resultz Therapeutic Area Treatment of Head Lice Licensee or Distributor Aralez/Medical Futures Licensed Territories Canada Takeda Belgium Intellectual Property Two patents granted in Canada expiring in 2023. Two patents granted in Belgium expiring in 2023. Reckitt-Benckiser United Kingdom, Ireland, France, Spain, Russia, Belarus, Portugal, Australia Two patents granted in each of the United Kingdom, Ireland, France, Spain, Portugal, and Australia expiring in 2023. Lapidot Palestine, Israel Pennsaid 2% Pennsaid 2% is a follow-on product to original Pennsaid. Pennsaid 2% is a topical pain product that combines a dimethyl sulfoxide (DMSO) based transdermal carrier with 2% diclofenac sodium, a leading NSAID, compared to 1.5% for original Pennsaid (described below). It is more viscous than original Pennsaid, is supplied in a metered dose pump bottle and has been approved in the U.S. for twice daily dosing compared to four times a day for Pennsaid. This provides Pennsaid 2% with potential advantages over Pennsaid and other competitor products and with patent protection. The following table summarizes where the Company’s partners have commercialized Pennsaid 2% or are working to obtain regulatory approval: Brand Pennsaid 2% Therapeutic Area Osteoarthritis of the knee Licensee or Distributor Horizon Pharma plc Licensed Territories United States Paladin Labs Inc.(1 ) Canada Intellectual Property Nineteen granted U.S. patents listed in the FDA’s Orange Book with latest expiry in 2030. One patent granted in Canada expiring in 2027. Pending patent application through 2033. NovaMedica LLC(2) Russia; some Community of Independent States Two patents granted in Russia with latest expiring in 2033. Sayre Therapeutics PVT Ltd.(3) India, Sri Lanka, Bangladesh and Nepal One patent granted in India expiring in 2027. Pending patent application through 2027. Gebro Pharma AG Switzerland and Liechtenstein One patent granted in Switzerland expiring in 2027. Pending patent application in Europe through 2033. (1) Regulatory approval not yet received in territory. (2) In February 2017, the Company received notification from NovaMedica LLC that the marketing authorization for Pennsaid 2% had been granted by the Russian Ministry of Health. The marketing authorization is inclusive of the non-prescription, human use of Pennsaid 2% in treating back pain, joint pain, muscle pain and inflammation and swelling in soft tissue and joints associated with trauma and rheumatic conditions (See “Pennsaid 2% - Russia”). (3) Partner is working to obtain regulatory approval in licensed territory. Pennsaid 2% - United States Pennsaid 2% was approved on January 16, 2014 in the U.S. for the treatment of the pain of osteoarthritis (OA) of the knee. OA is the most common joint disease affecting middle-age and older people. It is characterized by progressive damage to the joint cartilage and causes changes in the structures around the joint. These changes can include fluid accumulation, bony overgrowth and loosening and weakness of muscles and tendons, all of which may limit movement and cause pain and swelling. In the U.S., the rights to Pennsaid 2% were sold to Horizon Pharma plc (Horizon) for US$45.0 million in October 2014 (October 2014 Pennsaid 2% U.S. Sale Agreement). The Company earns revenue from product sales to Horizon under an exclusive manufacturing agreement that ends in 2029. In January 2015, Horizon launched its commercial sale and marketing of Pennsaid 2% in the U.S. Nuvo records revenue when it ships Pennsaid 2% product samples and commercial bottles to Horizon for Horizon’s sale into the U.S. market. The amount earned by Nuvo is based on a defined transfer price for each commercial bottle and product sample shipped to Horizon pursuant to its long-term, exclusive supply agreement with Horizon. Nuvo’s transfer price for Pennsaid 2% commercial bottles and product samples is not affected by Horizon’s net selling price for prescriptions filled in the U.S. The timing of Nuvo shipments to Horizon do not necessarily align with when U.S. patients fill prescriptions written by their physicians. For several weeks during 2017, Nuvo’s manufacturing facility in Varennes, Québec did not produce any commercial bottles of Pennsaid 2% for Horizon. This was part of a plan developed with Horizon to install new Pennsaid 2% packaging equipment and software systems. The new equipment was required to put Nuvo and Horizon in compliance with new Federal Drug Supply Chain Security Act (DSCSA) rules that mandate all manufacturers of drug products sold in the U.S. to serialize each individual package to enhance drug traceability in the event of an adverse event and to prevent drug counterfeiting. During this period of reduced production, Horizon was drawing down on their non-serialized inventory of Pennsaid 2% commercial bottles that had previously been shipped to them. On June 30, 2017, the Company was advised that the FDA was extending the serialization compliance date by one year - from November 17, 2017 to November 17, 2018. As a result of this change, Horizon requested that the Company deliver non-serialized commercial bottles to them before the equipment and software qualification process was completed. The Company completed its qualification and was fully compliant with the DSCSA rules during the fourth quarter. Pennsaid 2% - Russia In February 2017, the Company received notification from NovaMedica LLC (NovaMedica) that the marketing authorization for Pennsaid 2% had been granted by the Russian Ministry of Health. Pennsaid 2% is approved for the non-prescription, human use in treating back pain, joint pain, muscle pain and inflammation and swelling in soft tissue and joints associated with trauma and rheumatic conditions. Since the approval of Pennsaid 2% in Russia, the Company has been in ongoing discussions with NovaMedica regarding its commercialization plans for Pennsaid 2%. The approval of Pennsaid 2% in Russia as a non-prescription product, combined with the continued devaluation of the Ruble and the changing economic and competitive environment in Russia have made conditions for a successful commercial launch of Pennsaid 2% by NovaMedica difficult. NovaMedica has advised the Company that it may not be in a position to commercially launch Pennsaid 2% in Russia as a result of these challenging market conditions without the participation of a commercial partner. The Company and NovaMedica are in discussions regarding potential pathways forward which may include, but are not limited to, partnering Pennsaid 2% with NovaMedica and another third-party in Russia and/or termination of the existing license agreement between the Company and NovaMedica and a return of marketing authorization rights to the Company. Pennsaid 2% - India, Sri Lanka, Bangladesh and Nepal In March 2017, the Company announced an exclusive license agreement with Sayre Therapeutics to distribute, market and sell Pennsaid 2% in the Territory. Sayre Therapeutics filed their application for regulatory approval with the Drug Controller General of India in December 2017. If regulatory approval is obtained as anticipated, the Company expects commercial launches of Pennsaid 2% will commence in late 2018 or early 2019. The Company received an upfront payment and is eligible to receive milestone payments and a double-digit royalty on net sales. Nuvo will supply Pennsaid 2% to Sayre Therapeutics on an exclusive basis from its manufacturing facility in Varennes, Québec. Pennsaid 2% - Switzerland and Liechtenstein In December 2017, the Company announced it had entered into a license and distribution agreement with Gebro Pharma for the exclusive right to register, distribute, market and sell Pennsaid 2% in Switzerland and Liechtenstein. Gebro anticipates meeting with Swissmedic, the Swiss regulatory approval organization, towards the end of Q2 or early Q3 2018 for scientific advice regarding an application for Swiss regulatory approval. The Company is eligible to receive milestone payments and royalties on net sales of Pennsaid 2% in Switzerland and Liechtenstein and will earn product revenue from Gebro Pharma pursuant to an exclusive supply agreement. Pennsaid 2% - Unlicensed Territories The following table summarizes intellectual property for unlicensed Pennsaid 2% territories: Product Pennsaid 2% Therapeutic Areas Osteoarthritis of the knee and/or acute strains and sprains Intellectual Property Patents granted in Australia, Canada, Germany, Denmark, France, Great Britain, Greece, India, Ireland, Israel, Italy, Netherlands, Hong Kong, Japan, Mexico, New Zealand, Russia Federation, South Africa, expiring in 2027. Applications pending in 5 countries. Issued Russian patent and pending patent applications in Australia, Brazil, Canada, Chile, China, Europe, Hong Kong, Israel, Japan, and Mexico through 2033. Additional clinical and non-clinical trials may be required to support applications for the regulatory approval of Pennsaid 2% in other countries in which the Company, or other licensees and distributors, could potentially market the product. The Company was advised by regulatory authorities in Canada and the U.K. that the data from the Phase 2 trial conducted by its former U.S. licensee was insufficient to support approval of Pennsaid 2% in their respective countries and that additional clinical trials would be required. There can be no assurance that trials will yield successful results or that the required regulatory approvals will be obtained. The Company believes that many jurisdictions will base their regulatory approval of Pennsaid 2% on its U.S. FDA approval and will not require additional clinical trials. A separate registration procedure will be required in these respective countries before a licensing partner can launch the sale and marketing of Pennsaid 2%. 2016 Pennsaid 2% Phase 3 Clinical Trial In May 2017, the Company announced that its 2016 Pennsaid 2% Phase 3 Clinical Trial (2016 Pennsaid 2% Trial) did not meet its primary endpoint. The 2016 Pennsaid 2% Trial was conducted in Germany and enrolled 134 patients (the full analysis set or FAS) of which 122 patients followed the protocol (the per protocol set or PP) who had suffered a grade I or grade II ankle sprain as assessed by the investigator within 12 hours of injury. Patients were randomly assigned on a double- blind basis to an active arm or a control arm and applied either Pennsaid 2% or a control consisting of a topical vehicle that included all the constituent ingredients of Pennsaid 2%, except its active ingredient diclofenac sodium (the Control) to their injured ankle twice a day for 8 days. The 2016 Pennsaid 2% Trial commenced in November 2016 and was fully enrolled in March 2017. Results were tabulated for both the FAS and PP groups. Primary Endpoint The primary endpoint for the 2016 Pennsaid 2% Trial was reduction in pain on movement (POM) at day 3 in the FAS group. On average, patients treated with Pennsaid 2% had a larger reduction in POM scores over the course of the study. For the FAS group, the difference vs. Control was not statistically significant at the primary time point at day 3 (p=0.5074) or the secondary time point at day 5 (p=0.1642); however, was statistically significant at the secondary time point at day 8 (p=0.0099). In the PP group, the Pennsaid 2% group did not show a statistically significant improvement at day 3 (p=0.6996) or day 5 (p=0.1865), but did show a statistically significant improvement at day 8 (p=0.0154). After reviewing the 2016 Pennsaid 2% Trial results in detail, the Company met with its scientific advisors and regulatory consultants to determine what its next steps should be in relation to regulatory submissions of Pennsaid 2% in Canada, Australia and the E.U. At present, the Company has no plans to conduct another trial similar to the 2016 Pennsaid 2% Trial. The Company intends to pursue Pennsaid 2% registrations in select territories that will accept the existing clinical and technical data package. To support these activities, the Company will be seeking scientific advice from select regulatory agencies in Europe during the first half of 2018. The outcome of these meetings will help to determine if the significant body of evidence supporting the safe and effective use of Pennsaid and Pennsaid 2% will be sufficient to support the registration of Pennsaid 2% in select E.U. countries. Pennsaid Pennsaid, the Company’s first commercial topical pain product, is used to treat the signs and symptoms of OA of the knee. Pennsaid is a combination of a DMSO-based transdermal carrier and 1.5% diclofenac sodium and delivers the active drug through the skin at the site of pain. . Pennsaid no longer has patent protection in the territories where it is currently marketed by the Company’s partners. In Canada, Pennsaid is available by prescription only and multiple generic versions of Pennsaid have launched that have negatively impacted sales. In the other regions where Pennsaid is available, a prescription is not required (except the U.K.). Pennsaid Commercial Partners The following table summarizes where the Company’s partners have commercialized Pennsaid or are working to obtain regulatory approval: Brand Pennsaid Therapeutic Area Osteoarthritis of the knee Licensee or Distributor Paladin Labs Inc. Vianex S.A. Recordati S.p.A. Movianto UK Limited Licensed Territories(1) Canada Greece Italy U.K. (1) The Company’s patents associated with Pennsaid have expired. Heated Lidocaine/Tetracaine Patch The HLT Patch is a topical patch that combines lidocaine, tetracaine and heat, using proprietary Controlled Heat- Assisted Drug Delivery (CHADD™) technology. The CHADD unit generates gentle heating of the skin, and in a well-controlled clinical trial, demonstrated that it contributes to the efficacy of the HLT Patch by improving the flux rate of lidocaine and tetracaine through the skin. The HLT Patch resembles a small adhesive bandage in appearance and is applied to the skin 20 to 30 minutes prior to painful medical procedures, such as venous access, blood draws, needle injections and minor dermatologic surgical procedures. HLT Patch Commercial Partners: The following table summarizes where the Company’s partners have commercialized the HLT Patch or are working to obtain regulatory approval: Brand Synera(1) Therapeutic Area Local Dermal Analgesia (Patch) Licensee or Distributor Galen US Incorporated Licensed Territories United States Rapydan(1) Eurocept B.V. Europe, Russia(2), Turkey(2), Israel(2) and People’s Republic of China(2) Intellectual Property One granted U.S. patent listed in the FDA’s Orange Book expiring in 2020. Method of manufacturing patent that expires 2019 (U.S.). Granted European patent expiring in 2019. (1) Synera and Rapydan are the brand names for the HLT Patch in their respective jurisdiction. (2) Partner is responsible for obtaining regulatory approval in licensed territory. The Company holds the sales and marketing rights for the HLT Patch in Mexico, South America, Australia, Africa and most regions in Asia, although it is not approved in any of these territories. Under certain licensing agreements, the Company is required to make royalty payments to two companies for a combined 2.5% of annual net sales of the HLT Patch. Product Pipeline Foam Technology In March 2017, the Company acquired a U.S. patent with an expiry date of November 22, 2031 and pending applications in Canada, Europe and the U.S. covering DMSO-based foamable formulations for nominal consideration. The purchase agreement also included a commitment to remit a small portion of royalty payments, milestone payments or upfront payments received by the Company for out-licensing of products using the Foam Technology until the end of the applicable patent term provided the out-licensed products continue to be covered by a valid claim. The Company is in the process of meeting with its scientific advisors and regulatory consultants to determine opportunities to extend its commercial product pipeline using the Foam Technology. Selected Financial Information in thousands, except per share data Operations Product sales Royalties Contract revenue Total revenue Total operating expenses Other expenses Income before income taxes Income tax expense Net income from continuing operations Net loss from discontinued operations Net income Other comprehensive income (loss) Total comprehensive income Share Information Net income from continuing operations per common share - basic - diluted Average number of common shares outstanding - basic - diluted Financial Position Cash and cash equivalents Short-term investments Total assets Other obligations, including current portion Total liabilities Total equity Year ended December 31, 2017 $ Year ended December 31, 2016 $ 16,338 816 369 17,523 15,649 292 1,582 1 1,581 - 1,581 (3) 1,578 0.14 0.12 11,550 11,723 8,398 2,000 29,918 1,633 4,767 25,151 24,824 1,023 1,192 27,039 19,307 323 7,409 - 7,409 (3,180) 4,229 50 4,279 0.65 0.63 11,455 11,711 9,589 8,000 26,516 9 3,655 22,861 Non-IFRS Financial Measures The Company discloses non-IFRS measures that do not have standardized meanings prescribed by IFRS, but are considered useful by management, investors and other financial stakeholders to assess the Company’s performance and management from a financial and operational standpoint. Total operating expenses is defined as the sum of: cost of goods sold (COGS), research and development (R&D) expenses, general and administrative (G&A) expenses and net interest income. EBITDA refers to net income from continuing operations determined in accordance with IFRS, before depreciation and amortization, net interest income and income tax expense. EBITDA is used by management and many investors to determine the ability of an issuer to generate cash from operations. Adjusted EBITDA refers to EBITDA, plus stock-based compensation (SBC) expenses. Management believes Adjusted EBITDA is a useful supplemental measure from which to determine the Company’s ability to generate cash available for working capital, capital expenditures and income taxes. Fluctuations in Operating Results The Company anticipates that its quarterly and annual results of operations will be impacted for the foreseeable future by several factors including: the level of product sales to the Company’s customers, licensees and distributors, the timing and amount of royalties, milestones and other payments made or received pursuant to current and future licensing arrangements and fluctuations in foreign exchange rates. During the year ended December 31, 2017, the Company earned 87% [December 31, 2016 - 92%] of its product revenue from a single customer, Horizon. The Company earns product revenue from the sale of Pennsaid 2% commercial bottles and Pennsaid 2% samples to Horizon pursuant to a long-term, exclusive supply agreement. It is possible that quarterly and annual results of operations will be impacted for the foreseeable future by Horizon’s demand for Pennsaid 2% products due to Horizon’s promotional strategies, demand for the product in the U.S. market and how Horizon chooses to manage its internal inventory (See “Risk Factors - Dependency on Horizon”). The Company’s product revenue from Horizon is denominated in U.S. dollars. Fluctuations in the exchange rate of the Canadian dollar relative to the U.S. dollar could result in the Company realizing a higher or lower profit margin on sales of its product to Horizon. Prior to March 1, 2016, the Company’s discontinued operations included allocations of certain transactions reported in the accounts of Nuvo. Management believes both the assumptions and allocations underlying the discontinued operations are reasonable. However, as a result of the combined carve-out methodology used to determine the results of Crescita, the discontinued operations may not necessarily be indicative of the operating results and financial position that would have resulted had Crescita historically operated as a stand-alone entity. As a result, it is possible that quarterly and annual results of the Company’s continuing operations may fluctuate when compared to periods prior to March 1, 2016. Due to these factors, the Company believes that the period-to-period comparisons of its operating results are not necessarily a good indicator of future performance. Results of Operations Product Sales in thousands Pennsaid 2% Pennsaid HLT bulk Total product sales Year ended December 31, 2017 Year ended December 31, 2016 $ 14,242 1,966 130 16,338 $ 22,806 1,558 460 24,824 Product sales, which represent the Company’s sales to customers, licensees and distributors, were $16.3 million for the year ended December 31, 2017 compared to $24.8 million for the year ended December 31, 2016. Pennsaid 2% Under the terms of the October 2014 Pennsaid 2% U.S. Sale Agreement, the Company earns revenue from product sales of Pennsaid 2% to Horizon. All Pennsaid 2% product sales relate to the U.S. market. The Company believes Horizon’s orders are influenced by Horizon’s management strategies and inventory levels, as well as U.S. market demand for commercial product. Pennsaid 2% product sales were $14.2 million for the year ended December 31, 2017 compared to $22.8 million for the year ended December 31, 2016. In the current year, product sales included $10.2 million of the commercial format and $4.0 million of the physician sample format. In the comparative year, product sales included $14.6 million of the commercial format and $8.2 million of the physician sample format. The decrease in sales for the year ended December 31, 2017 related to Horizon’s decision to draw down on its existing inventory previously supplied by the Company and for several weeks during 2017, the manufacturing facility in Varennes, Québec did not produce any commercial bottles of Pennsaid 2% for Horizon due to the installation and qualification of the Company’s new commercial and sample production equipment. The Company completed its qualification on its commercial equipment and was fully compliant with the DSCSA rules before the year ended December 31, 2017. According to IMS Health, approximately 434,000 Pennsaid 2% prescriptions were dispensed in the year ended December 31, 2017 compared to 457,000 prescriptions in the year ended December 31, 2016. Based on this data, Pennsaid 2% continues to be actively prescribed by physicians. Pennsaid Product sales of Pennsaid were $2.0 million for the year ended December 31, 2017 compared to $1.6 million for the year ended December 31, 2016. In the current year, the $0.4 million increase in Pennsaid product sales was primarily attributable to a $0.8 million increase in sales to the Company’s partner in Greece, partially offset by a $0.4 million decrease in sales to the Company’s partner in Italy. Geographically, for the year ended December 31, 2017, all Pennsaid product sales were generated from the Company’s partners in the E.U. and Canada. HLT Bulk HLT bulk sales were $0.1 million for the year ended December 31, 2017 compared to sales of $0.5 million for the year ended December 31, 2016. HLT bulk sales relate to Nuvo’s sale of the bulk drug product that is used in manufacturing the HLT Patch for both the U.S. and E.U. markets. The bulk drug product is shipped to a contract manufacturing organization in the U.S. that manufactures the HLT Patch. Significant Customers As the Company sells product in a limited number of markets through exclusive agreements, it receives most of its product sales from a limited number of customers. Product sales, derived from the Company’s current four largest customers, are illustrated in the following table: in thousands, except percentages Four largest customers % of total product sales Largest customer as % of total product sales Other Revenue in thousands Royalties Contract revenue Total other revenue Year ended December 31, 2017 $ Year ended December 31, 2016 $ 16,038 98% 87% 24,282 98% 92% Year ended December 31, 2017 Year ended December 31, 2016 $ 816 369 1,185 $ 1,023 1,192 2,215 Royalties The Company receives royalty revenue from: Paladin Labs Inc. (Paladin), its Canadian licensee for Pennsaid and the authorized generic of Pennsaid; Eurocept B.V. (Eurocept), its European licensee for Rapydan; and Galen US Incorporated (Galen), its U.S. licensee for Synera. Royalties from each licensee are determined using agreed upon formulas based on either a definition of the licensee’s net sales or gross profits as defined in each agreement. The Company recognizes royalty revenue based on either the net sales or gross profits of each licensee. Royalty revenue decreased to $0.8 million for the year ended December 31, 2017 compared to $1.0 million for the year ended December 31, 2016. Contract Revenue Contract revenue for the year ended December 31, 2017 decreased to $0.4 million compared to $1.2 million for the year ended December 31, 2016. Contract revenue was mainly derived from development services provided by the Company to its partners. Operating Expenses in thousands Cost of goods sold Research and development expenses General and administrative expenses Net interest income Total operating expenses Year ended December 31, 2017 Year ended December 31, 2016 $ 8,115 571 7,120 (157) 15,649 $ 11,357 1,417 6,677 (144) 19,307 Total operating expenses for the year ended December 31, 2017 were $15.6 million, a decrease from $19.3 million for the year ended December 31, 2016. Cost of Goods Sold COGS for the year ended December 31, 2017 was $8.1 million compared to $11.4 million for the year ended December 31, 2016. COGS decreased in the current year due to decreased product sales. Gross margin on product sales was $8.2 million or 50% for the year ended December 31, 2017 compared to a gross margin of $13.5 million or 54% for the year ended December 31, 2016. The Company’s gross margin on product sales was impacted by the volume and mix of products sold during the year. The Company’s gross margin was also impacted by the Canadian dollar versus the U.S. dollar, the currency in which it sources certain Pennsaid 2% and Pennsaid raw materials. Research and Development R&D expenses were $0.6 million for the year ended December 31, 2017 compared to $1.4 million for the year ended December 31, 2016. The Company completed the 2016 Pennsaid 2% Trial in May of 2017. See “Overview - Pennsaid 2%” for a summary of the 2016 Pennsaid 2% Trial. R&D expenses incurred in the comparative year included costs attributable to both the 2016 Pennsaid 2% Trial and the 2015 Pennsaid 2% Trial to support regulatory applications for marketing approval of Pennsaid 2% for the treatment of acute pain in the E.U., Canada and Australia. General and Administrative G&A expenses were $7.1 million for the year ended December 31, 2017 compared to $6.7 million for the year ended December 31, 2016. The net increase in the current year of $0.4 million was primarily attributable to employee head count which resulted from the strengthening of the executive and senior management team to facilitate the Company’s growth strategy, offset by a reduction in SBC. Net Interest Income Net interest income was $0.2 million for the year ended December 31, 2017 compared to $0.1 million for the year ended December 31, 2016. The Company earns interest income on its short-term investments and its high interest savings account. Foreign Currency Loss For the year ended December 31, 2017, the Company experienced a net foreign currency loss of $0.3 million which is consistent with the comparative year’s loss of $0.3 million. Foreign currency gains or losses are recognized based on movements in the Canadian dollar against U.S. dollar and euro denominated cash, receivables, payables and other obligations Net Income and Total Comprehensive Income in thousands Net income before income taxes from continuing operations Income tax expense Net income from continuing operations Net loss from discontinued operations Net income Unrealized gain (loss) on translation of foreign operations Total comprehensive income Year ended December 31, 2017 Year ended December 31, 2016 $ 1,582 1 1,581 - 1,581 (3) 1,578 $ 7,409 - 7,409 (3,180) 4,229 50 4,279 Net Income from Continuing Operations Net income from continuing operations was $1.6 million for the year ended December 31, 2017 compared to $7.4 million for the year ended December 31, 2016. In the current year, the decrease was primarily attributable to a $5.2 million decrease in gross margin on product sales, a $1.0 million decrease in royalties and contract revenue and a $0.4 million increase in G&A expenses, partially offset by a $0.8 million decrease in R&D expenses. Net Loss from Discontinued Operations Prior to the Reorganization, Nuvo operated two distinct business units: Nuvo and Crescita. Crescita has been presented as discontinued operations. The operating results of the discontinued operations are presented below. in thousands Discontinued Operations Product sales Royalties Total revenue Total operating expenses Foreign currency (gain) loss Net loss from discontinued operations Year ended December 31, 2017 Year ended December 31, 2016 $ - - - - - - $ 45 14 59 3,247 (8) (3,180) Net loss from discontinued operations was $nil for the year ended December 31, 2017 compared to a $3.2 million loss for the year ended December 31, 2016. The decrease was attributable to the timing of the Reorganization, which was effective March 1, 2016. Net Income Net income for the year ended December 31, 2017 was $1.6 million compared to $4.2 million for the year ended December 31, 2016. In the current year, the decrease was primarily attributable to a $5.2 million decrease in gross margin on product sales, a $1.0 million decrease in royalties and contract revenue and a $0.4 million increase in G&A expenses, partially offset by a $0.8 million decrease in R&D expenses. In the comparative year, the Company’s net income from continuing operations was offset by the two-month net loss from discontinued operations of $3.2 million. Net Income Per Common Share share figures in thousands Net income from continuing operations per common share - basic - diluted Average number of common shares outstanding (in thousands) - basic - diluted Year ended December 31, 2017 Year ended December 31, 2016 $ 0.14 0.12 11,550 11,723 $ 0.65 0.63 11,455 11,711 For the year ended December 31, 2017, the Company reported net income from continuing operations of $0.14 per common share compared to $0.65 per common share for the comparative year. On a diluted basis, for the year ended December 31, 2017, net income from continuing operations per common share was $0.12 compared to net income from continuing operations of $0.63 for the comparative year. The weighted average number of common shares outstanding on a basic and diluted basis was 11.6 million and 11.7 million for the year ended December 31, 2017 and 11.5 million and 11.7 million on a basic and diluted basis for the year ended December 31, 2016. The increase in average basic number of shares outstanding was attributable to employee stock options exercised. For the year ended December 31, 2017, the weighted average number of common shares on a diluted basis included a 143,000 share adjustment for the dilutive impact of stock options and a 30,000 share adjustment for the dilutive impact of Share Appreciation Rights (SARs). For the year ended December 31, 2016, the weighted average number of common shares on a diluted basis included a 235,000 share adjustment for the dilutive impact of stock options, a 1,000 share adjustment for the dilutive impact of warrants, a 9,000 share adjustment for the dilutive impact of Deferred Share Units (DSUs) and a 11,000 share adjustment for the dilutive impact of SARs. Segments IFRS 8 - Operating Segments, requires operating segments to be determined based on internal reports that are regularly reviewed by the chief operating decision maker for the purpose of allocating resources to the segment and for assessing its performance. With the completion of the Reorganization on March 1, 2016, operating results have been restated to reflect Crescita as discontinued operations. Accordingly, the Company now operates in one segment. Geographic Information The Company’s revenue from continuing operations is derived from sales to, and licensing revenue derived from, external customers located in the following geographic areas: in thousands United States Europe Canada Other Total revenue Year ended December 31, 2017 Year ended December 31, 2016 $ 15,084 1,875 551 13 17,523 $ 24,528 1,712 799 - 27,039 Adjusted EBITDA EBITDA is a non-IFRS financial measure. The term EBITDA does not have any standardized meaning under IFRS and therefore, may not be comparable to similar measures presented by other companies. The Company defines Adjusted EBITDA as net income from continuing operations before net interest income, plus income tax expense, depreciation, amortization and SBC. Management believes Adjusted EBITDA is a useful supplemental measure from which to determine the Company’s ability to generate cash available for working capital, capital expenditures and income taxes. The following is a summary of how EBITDA and Adjusted EBITDA are calculated. in thousands Net income from continuing operations Add back: Net interest income Income tax expense Depreciation and amortization EBITDA Add back: Stock-based compensation Adjusted EBITDA Year ended December 31, 2017 Year ended December 31, 2016 $ 1,581 (157) 1 258 1,683 486 2,169 $ 7,409 (144) - 225 7,490 1,383 8,873 Adjusted EBITDA decreased to $2.2 million for the year ended December 31, 2017 compared to $8.9 million for the year ended December 31, 2016. The decrease in Adjusted EBITDA for the current year was primarily related to a decrease in gross margin, royalties and contract revenue, partially offset by a combined decrease in G&A and R&D expenses. Liquidity and Capital Resources Year ended December 31, 2017 Year ended December 31, 2016 in thousands Net income from continuing operations Net loss from discontinued operations Net income Items not involving current cash flows Cash provided by operations Net change in non-cash working capital Cash provided by operating activities Cash used in investing activities Cash provided by (used in) financing activities Effect of exchange rates on cash Net change in cash during the year Cash, beginning of the year Cash, end of the year Short-term investments Cash and short-term investments $ 1,581 - 1,581 1,252 2,833 1,658 4,491 (5,403) 5 (284) (1,191) 9,589 8,398 2,000 10,398 $ 7,409 (3,180) 4,229 2,132 6,361 (2,493) 3,868 (8,368) (34,708) 117 (39,091) 48,680 9,589 8,000 17,589 Cash and Short-term Investments Cash and short-term investments were $10.4 million as at December 31, 2017 compared to $17.6 million as at December 31, 2016. The decrease was primarily related to the US$7.0 million ($8.8 million) that was paid to Piedmont to acquire the ex-U.S. product and intellectual property rights to Resultz. Operating Activities Cash provided by operations was $2.8 million for the year ended December 31, 2017 compared to $6.4 million for the year ended December 31, 2016. In the current year, the decrease in cash provided by operations was primarily due to a decrease in revenue. Overall cash provided by operating activities increased to $4.5 million for the year ended December 31, 2017 compared to $3.9 million for the year ended December 31, 2016. In the current year, the decrease in cash provided by operations was offset by a $4.2 million recovery in working capital. In the current year, the $1.7 million recovery of non-cash working capital was primarily attributable to a $0.5 million decrease in accounts receivable due to lower product sales in the fourth quarter of 2017, a $1.3 million decrease in inventories and a $1.1 million decrease in other current assets due to the installation of the Company’s new commercial and sample production equipment, partially offset by a $1.2 million decrease in accounts payable and accrued liabilities. In the comparative year, the $2.5 million investment in non-cash working capital was attributable to a $3.2 million decrease in accounts payable and accrued liabilities, primarily the result of the settlement of DSUs on March 1, 2016 and the revaluation of SBC, a $1.8 million increase in inventories due to increased raw material purchases to meet the safety-stock inventory requirements as part of the Horizon supply agreement, slightly offset by a $2.8 million decrease in accounts receivable. Investing Activities Net cash used in investing activities was $5.4 million for the year ended December 31, 2017 compared to $8.4 million for the year ended December 31, 2016. In both the current and comparative years, cash used in investing activities included the acquisition of property, plant and equipment for production and laboratory equipment acquired by the Company’s manufacturing facility in Varennes, Québec. In the current year, $6.0 million of the Company’s short-term investments matured and were not re-invested by the end of the year. In the comparative year, the Company purchased $8.0 million of short-term investments. In the current year, Nuvo acquired the global, ex-U.S. product and intellectual property rights to Resultz from Piedmont. Under the terms of the agreement, Nuvo paid US$7.0 million ($8.8 million) on close to Piedmont from cash on hand. Financing Activities Net cash provided by financing activities was $5,000 for the year ended December 31, 2017 compared to net cash used in financing activities of $34.7 million for the year ended December 31, 2016. In the comparative year, the Company transferred $35.0 million to Crescita as part of the Reorganization of the Company. Selected Quarterly Information The following is selected quarterly financial information for the Company’s continuing operations over the last eight quarterly reporting periods. in thousands, except per share data Product sales Royalties Contract revenue Cost of goods sold Research and development expenses General and administrative expense Net interest income Other expenses (income) Net income Net income per common share - basic - diluted Product sales Royalties Contract revenue Cost of goods sold Research and development expenses General and administrative expense Net interest income Other expenses (income) Net income Net income per common share - basic - diluted Q1 2017 $ 6,653 222 107 2,772 311 1,671 (38) 70 2,196 0.19 0.19 Q1 2016 $ 7,325 309 208 3,135 208 2,091 (56) 536 1,928 0.17 0.15 Q2 2017 $ 2,786 176 138 1,451 Q3 2017 $ 2,700 199 57 1,615 Q4 2017 $ 4,199 219 67 2,277 2017 Total $ 16,338 816 369 8,115 186 1,644 (34) 56 (203) (0.02) (0.02) Q2 2016 $ 7,317 134 655 3,159 211 2,260 (22) 7 2,491 38 1,445 (46) 129 (226) (0.02) (0.02) Q3 2016 $ 4,988 323 207 2,535 394 1,462 (29) (95) 1,251 36 2,360 (39) 37 (186) (0.02) (0.02) Q4 2016 $ 5,194 257 122 2,528 604 864 (37) (125) 1,739 571 7,120 (157) 292 1,581 0.14 0.12 2016 Total $ 24,824 1,023 1,192 11,357 1,417 6,677 (144) 323 7,409 0.22 0.21 0.11 0.10 0.15 0.12 0.65 0.63 Fourth Quarter Results in thousands Product sales Royalties Contract revenue Total revenue Cost of goods sold Research and development General and administrative expenses Net interest income Total operating expenses Other expenses (income) Net income (loss) from continuing operations Net loss from discontinued operations Net income (loss) Other comprehensive income (loss) Total comprehensive income (loss) Three months ended December 31, 2017 Three months ended December 31, 2016 $ 4,199 219 67 4,485 2,277 36 2,360 (39) 4,634 37 (186) - (186) (2) (188) $ 5,194 257 122 5,573 2,528 604 864 (37) 3,959 (125) 1,739 - 1,739 4 1,743 Operating Results Total revenue for the three months ended December 31, 2017 was $4.5 million compared to $5.6 million for the three months ended December 31, 2016. The decrease in revenue was primarily related to a $1.2 million decrease in Pennsaid 2% product sales. Total operating expenses for the three months ended December 31, 2017 increased to $4.6 million compared to $4.0 million for the three months ended December 31, 2016. The increase in operating expenses was primarily attributable to an increase in G&A, partially offset by a decrease in COGS and R&D expenses. COGS for the three months ended December 31, 2017 was $2.3 million compared to $2.5 million for the three months ended December 31, 2016. The decrease in COGS was primarily related to a decrease in Pennsaid 2% product sales. The decrease in product sales reduced the gross margin on product sales to $1.9 million or 46% for the three months ended December 31, 2017 compared to $2.7 million or 51% for the three months ended December 31, 2016. R&D expenses decreased to $36,000 for the three months ended December 31, 2017 compared to $0.6 million for the three months ended December 31, 2016. The decrease in the quarter related to costs associated with the 2016 Pennsaid 2% Trial for the treatment of acute ankle sprains which were recognized in the comparative period. The 2016 Pennsaid 2% Trial was completed in May of 2017 and the majority of the costs were previously recognized. G&A expenses increased to $2.4 million for the three months ended December 31, 2017 compared to $0.9 million for the three months ended December 31, 2016. The increase in the current quarter of $1.5 million was primarily related to a $0.6 million increase in SBC expense and increased employee head count which resulted from the strengthening of the executive and senior management team to facilitate the Company’s growth strategy. Net interest income was $39,000 for the three months ended December 31, 2017 compared to $37,000 for the three months ended December 31, 2016. Other expenses (income) primarily consists of net foreign currency gains or losses in both the current and comparative quarter which will vary based on fluctuations in foreign currency rates. Net loss from continuing operations was $0.2 million for the three months ended December 31, 2017 compared to net income from continuing operations of $1.7 million for the three months ended December 31, 2016. The decrease in net income from continuing operations was primarily related to a decrease in gross margin and an increase in G&A expenses. Net loss for the three months ended December 31, 2017 was $0.2 million compared to a net income of $1.7 million for the three months ended December 31, 2016. Liquidity in thousands Net income (loss) Items not involving current cash flows Cash provided by operations Net change in non-cash working capital Cash provided by (used in) operating activities Cash used in investing activities Cash (used in) provided by financing activities Effect of exchange rates on cash Net change in cash Cash, beginning of period Cash, end of period Three months ended December 31, 2017 Three months ended December 31, 2016 $ (186) 239 53 3,015 3,068 (10,432) (1) (7,365) 34 (7,331) 15,729 8,398 $ 1,739 (42) 1,697 (1,731) (34) (57) 165 74 109 183 9,406 9,589 Cash was $8.4 million as at December 31, 2017, a decrease of $7.3 million compared to $15.7 million at September 30, 2017. The decrease was primarily related to the US$7.0 million ($8.8 million) that was paid to Piedmont to acquire the ex-U.S. product and intellectual property rights to Resultz. Cash provided by operating activities was $3.1 million for the three months ended December 31, 2017 compared to cash used in operating activities of $34,000 for the three months ended December 31, 2016. In the current quarter, a decrease in cash provided by operations was offset by a $4.7 million recovery in non-cash working capital. In the current quarter, the $3.0 million recovery in non-cash working capital was primarily related to a $1.0 million decrease in accounts receivable due to lower product sales in the fourth quarter of 2017 and a $0.5 million decrease in inventories. Additionally, other current assets decreased by $0.8 million and accounts payable increased $0.7 million. In the comparative quarter, the $1.7 million investment in non-cash working capital was primarily related to an increase in inventories due to increased raw material purchases to meet safety-stock inventory requirements as part of the Horizon supply agreement, a decrease in accounts payable and accrued liabilities, primarily due to the settlement of termination SARs and the revaluation of SARs, slightly offset by a $0.6 million decrease in accounts receivable. Net cash used in investing activities was $10.4 million for the three months ended December 31, 2017 compared to $57,000 for the three months ended December 31, 2016. In both the current and comparative quarters, cash used in investing activities included the acquisition of property, plant and equipment for production and laboratory equipment acquired by the Company’s manufacturing facility in Varennes, Québec. In the current quarter, Nuvo acquired the global, ex-U.S. product and intellectual property rights to Resultz from Piedmont. Under the terms of the agreement, Nuvo paid US$7.0 million ($8.8 million) on close to Piedmont from cash on hand. Net cash used in financing activities was $1,000 for the three months ended December 31, 2017 compared to net cash provided by financing activities of $0.2 million for the three months ended December 31, 2016. In the comparative quarter, the Company received $0.2 million in proceeds for the issuance of common shares. Financial Instruments IFRS 7 - Financial Instruments: Disclosures requires disclosure of a three-level hierarchy that reflects the significance of the inputs used in making fair value measurements. Fair values of assets and liabilities included in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Assets and liabilities in Level 2 include those where valuations are determined using inputs other than quoted prices for which all significant outputs are observable, either directly or indirectly. Level 3 valuations are those based on inputs that are unobservable and significant to the overall fair value measurement. Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes to the ability to observe valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. The Company did not have any transfer of assets and liabilities between Level 1, Level 2 and Level 3 of the fair value hierarchy during the year ended December 31, 2017. The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies. However, considerable judgment is required to develop these estimates. Accordingly, these estimated values are not necessarily indicative of the amounts the Company could realize in a current market exchange. The estimated fair value amounts can be materially affected by the use of different assumptions or methodologies. The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis as at December 31, 2017: in thousands Assets: Short-term investments Total assets Liabilities: Share appreciation rights Contingent and variable consideration related to the Resultz acquisition Total liabilities Total $ 2,000 2,000 74 1,626 1,700 Using Quoted Prices in Active Markets for Identical Assets (Level 1) $ Using Significant Other Unobservable Inputs (Level 2) $ Using Significant Unobservable Inputs (Level 3) $ - - - - - 2,000 2,000 74 - 74 - - - 1,626 1,626 The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis as at December 31, 2016: in thousands Assets: Short-term investments Total assets Liabilities: Share appreciation rights Total liabilities Total $ 8,000 8,000 1,031 1,031 Using Quoted Prices in Active Markets for Identical Assets (Level 1) $ Using Significant Other Unobservable Inputs (Level 2) $ Using Significant Unobservable Inputs (Level 3) $ - - - - 8,000 8,000 1,031 1,031 - - - - Level 2 assets include guaranteed investment certificates held by the Company that are valued at fair value and the fair value approximates the carrying value due to the short-term nature. Level 2 liabilities include obligations of the Company for the SARs Plan. The fair values of each tranche of SARs issued and outstanding are revalued at each reporting period using the Black-Scholes option pricing model. The Company accrued $0.1 million for SARs as at December 31, 2017 [December 31, 2016 - $1.0 million]. Level 3 liabilities include the fair value of contingent and variable consideration related to the acquisition of the ex- U.S. rights to Resultz. The fair value is estimated using a present value technique disclosed in Note 4, “Acquisition of Resultz Product and Intellectual Property Rights” of the Company’s Consolidated Financial Statements for the year ended December 31, 2017. The fair value of $1.6 million is estimated by probability weighting the estimated future cash outflows, adjusting for risk and discounting at rates ranging from 20% - 30%. The probability-weighted cash outflows reflect management’s estimates of a 0% - 25% probability that various milestones will be achieved. For the variable consideration, the estimated future cash flows are not probability weighted as the consideration is based on a percentage of net sales in certain markets, not on specific milestones. The discount rate used is based on the Company’s risk-adjusted estimated weighted average cost of capital at the reporting date. The effects on the fair value of risk and uncertainty in the future cash flows are dealt with by adjusting the estimated cash flows rather than adjusting the discount rate. The contingent consideration is driven by the anticipated sales volumes of Resultz in certain markets. A 10% decrease in the projected sales volumes of Resultz in these markets would decrease the fair value of the contingent consideration liability by $0.4 million. Rates currently available to the Company for long-term obligations, with similar terms and remaining maturities, have been used to estimate the fair value of the finance lease and other obligations. These fair values approximate the carrying values for all instruments. Financial Risk Management The following is a discussion of liquidity risk, credit risk and market risk and related mitigation strategies that have been identified. This is not an exhaustive list of all risks nor will the mitigation strategies eliminate all risks listed. Liquidity Risk While the Company had $8.4 million in cash and cash equivalents and $2.0 million in short-term investments as at December 31, 2017, it was dependent on a single customer for substantially all of its revenue. During the year ended December 31, 2017, the Company earned 87% [December 31, 2016 - 92%] of its product revenue from a single customer, Horizon. The Company earns product revenue from Horizon pursuant to a long-term, exclusive supply agreement, as well as contract service revenue. The loss of this customer would have a material adverse effect on the Company’s revenue, operating results and cash flows. The Company continues to seek business opportunities to diversify its customer base in order to help mitigate this concentration risk. On December 29, 2017, the Company acquired the global, ex-U.S. product and intellectual property rights to Resultz from Piedmont which includes existing royalty streams in the Royalty Markets. The benefits of the acquisition include expanding the Company’s portfolio of commercial products and Resultz can be produced at Nuvo’s Varennes, Québec manufacturing facility. The Company has contractual obligations related to accounts payable and accrued liabilities, purchase commitments and other obligations of $3.3 million that are due in less than a year and $1.0 million of contractual obligations that are payable from 2019 to 2023. Credit Risk The Company’s cash, cash equivalents and short-term investments subject the Company to a concentration of credit risk. As at December 31, 2017, the Company had $8.4 million invested with two financial institutions in various bank accounts. These financial institutions are major Canadian banks, which the Company believes lessens the degree of credit risk. Additionally, the Company maintains $2.0 million in short-term investments with a creditworthy Canadian insurance company. The Company, in the normal course of business, is exposed to credit risk from its global customers, most of whom are in the pharmaceutical industry. The accounts receivable are subject to normal industry risks in each geographic region in which the Company operates. The Company attempts to manage these risks prior to the signing of distribution or licensing agreements by dealing with creditworthy customers; however, due to the limited number of potential customers in each market, this is not always possible. In addition, a customer’s creditworthiness may change, subsequent to becoming a licensee or distributor, and the terms and conditions in the agreement may prevent the Company from seeking new licensees or distributors in these territories during the term of the agreement. As at December 31, 2017, the Company’s largest customer represented 76% [December 31, 2016 - 73%] of accounts receivable. Pursuant to their collective terms, accounts receivable were aged as follows: in thousands Current 0 - 30 days past due 31 - 60 days past due Over 60 days past due December 31, 2017 $ 1,731 128 7 9 1,875 December 31, 2016 $ 2,159 11 216 - 2,386 Interest Rate Risk All finance lease obligations are at fixed interest rates. Currency Risk The Company operates globally, which gives rise to a risk that income and cash flows may be adversely affected by fluctuations in foreign currency exchange rates. The Company is primarily exposed to the U.S. dollar and euro, but also transacts in other foreign currencies. The Company currently does not use financial instruments to hedge these risks. The significant balances in foreign currencies were as follows: in thousands Cash Accounts receivable Other current assets Accounts payable and accrued liabilities Euros U.S. Dollars December 31, 2017 € December 31, 2016 € December 31, 2017 $ December 31, 2016 $ 621 - - (32) 589 242 - - (305) (63) 1,290 1,378 - (751) 1,917 3,929 1,636 - (289) 5,276 Based on the aforementioned net exposure as at December 31, 2017, and assuming that all other variables remain constant, a 10% appreciation or depreciation of the Canadian dollar against the U.S. dollar would have an effect of $0.2 million on total comprehensive income and a 10% appreciation or depreciation of the Canadian dollar against the euro would have an effect of $0.1 million on total comprehensive income. In terms of the euro, the Company has two significant exposures: its euro denominated-cash held in its Canadian operations and sales of Pennsaid by the Canadian operations to European distributors. In terms of the U.S. dollar, the Company has three significant exposures: its U.S. dollar-denominated cash held in its Canadian operations, the cost of purchasing raw materials either priced in U.S. dollars or sourced from U.S. suppliers that are needed to produce Pennsaid 2%, Pennsaid or other products at the Canadian manufacturing facility and revenue generated in U.S. dollars from agreements with Horizon, Galen and Eurocept. For the year ended December 31, 2017, the Company did not hold an investment in active foreign operations. The Company does not currently hedge its euro cash flows. Sales to European distributors for Pennsaid are primarily contracted in euros. The Company receives payments from the distributors in its euro bank accounts and uses these funds to pay euro denominated expenditures. Periodically, the Company reviews the amount of euros held, and if they are excessive compared to the Company’s projected future euro cash flows, they may be converted into U.S. or Canadian dollars. If the amount of euros held is insufficient, the Company may convert a portion of other currencies into euros. The Company does not currently hedge its U.S. dollar cash flows. The Company’s U.S. expenditures are funded using the Company’s U.S. dollar-denominated cash and payments received under the terms of the agreements with Horizon, Galen and Eurocept. Periodically, the Company reviews its projected future U.S. dollar cash flows and if the U.S. dollars held are insufficient, the Company may convert a portion of its other currencies into U.S. dollars. If the amount of U.S. dollars held is excessive, they may be converted into Canadian dollars or other currencies as needed for the Company’s other operations. Contractual Obligations The following table lists the Company’s contractual obligations for the twelve months ending December 31 as follows: in thousands Finance lease obligations Operating leases Other obligations(1) (1) Other obligations include accounts payable and accrued liabilities. Litigation 2018 $ 3 162 3,134 3,299 2019 $ 3 198 - 201 2020 and thereafter $ 3 828 - 831 Total $ 9 1,188 3,134 4,331 From time-to-time, during the ordinary course of business, the Company may be threatened with, or may be named as, a defendant in various legal proceedings including lawsuits based upon product liability, personal injury, breach of contract and lost profits or other consequential damage claims. Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements. Related Party Transactions Crescita Therapeutics Inc. Subsequent to the Reorganization, Nuvo and Crescita were related parties due to shared key management personnel. Effective March 1, 2016, Nuvo and Crescita entered into a reciprocal transitional services agreement with a term of 18 months. Under the transitional services agreement, (a) Nuvo provided Crescita corporate-level employee services, quality assurance support and facility rental, and (b) Crescita provided Nuvo corporate-level employee services, R&D, legal support and facility and equipment rental. As a result of the restructuring of key management personnel, Nuvo and Crescita are no longer related parties. For the year ended December 31, 2016, services provided to Crescita were $0.3 million and services received from Crescita were $0.4 million. Key Management Compensation Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Company, including directors. Key management includes five executive officers and five non-employee directors. Compensation for the Company’s key management personnel was as follows: Short-term wages, bonuses and benefits (i) Share-based payments Total key management compensation Included in: Research and development expenses General and administrative expenses Total key management compensation Year ended December 31, 2017 $ Year ended December 31, 2016 $ 2,133 457 2,590 - 2,590 2,590 1,772 968 2,740 11 2,729 2,740 (i) For the year ended December 31, 2017, certain officers of the Company were assessed on the achievement of corporate objectives. The Company expects the achievement of these targets to be determined during the first quarter of 2018. Outstanding Share Data The number of common shares outstanding as at December 31, 2017 was 11.6 million unchanged from September 30, 2017. As at December 31, 2017, there were 1,029,000 options outstanding of which 515,000 have vested. Critical Accounting Policies and Estimates The preparation of Consolidated Financial Statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting periods. Management has identified the following accounting estimates that it believes are most critical to understanding the Consolidated Financial Statements and those that require the application of management’s most subjective judgments, often requiring the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. The Company’s actual results could differ from these estimates and such differences could be material. All significant accounting policies are disclosed in Note 3, “Summary of Significant Accounting Policies” of the Company’s Consolidated Financial Statements for the year ended December 31, 2017. Use of Estimates and Judgments The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of these Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates, and such differences could be material. Key areas of estimation or use of managerial assumptions are as follows: (i) Purchase Price Allocation, Intangible Assets and Goodwill: The purchase price allocation process resulting from a business combination requires management to estimate the fair value of identifiable assets acquired including intangible assets and liabilities assumed including any contingent and variable consideration. The Company uses valuation techniques to determine fair values, which are generally based on forecasted future net cash flows discounted to present value. These valuations are closely linked to the assumptions used by management on the future performance of the related assets and the discount rates applied. See Note 4, “Acquisition of Resultz Product and Intellectual Property Rights” of the Company’s Consolidated Financial Statements for the year ended December 31, 2017 for the assumptions used by management and the discount rates applied. The Company’s accounting policy relating to transactions or other events considered to be a business combination is described in Note 3, “Summary of Significant Accounting Policies - Business Combinations” of the Company’s Consolidated Financial Statements for the year ended December 31, 2017. In applying this policy, judgment is used when determining whether such transactions should be treated as an asset acquisition or a business combination. During the year ended December 31, 2017, management concluded that the acquisition of the ex- U.S. product and intellectual property rights to Resultz was a business combination in the scope of IFRS 3, Business Combinations, as the acquired assets met the definition of a business. (ii) Discontinued Operations: The Company’s discontinued operations reflect Crescita on a combined carve-out basis as if it had always operated as a stand-alone entity. Prior to March 1, 2016, Nuvo paid certain costs for Crescita and performed certain activities on behalf of Crescita. As a result, the Company’s discontinued operations include allocations of certain transactions reported in the accounts of Nuvo. These cost allocations have been determined on a basis considered by the Company to be a reasonable reflection of the utilization of services provided to Crescita. Compensation-related costs have been allocated using methodologies primarily based on proportionate time spent on Nuvo and Crescita’s respective activities. Management believes both the assumptions and allocations underlying the discontinued operations are reasonable. However, as a result of the combined carve-out methodology in determining the results of Crescita, the discontinued operations may not necessarily be indicative of the operating results and financial position that would have resulted had Crescita historically operated as a stand-alone entity. (iii) Share-based Payments: The Company measures the cost of share-based payments, either equity or cash-settled with employees by reference to the fair value of the equity instrument or underlying equity instrument at the date on which they are granted. In addition, cash-settled, share-based payments are revalued to fair value at every reporting date. Estimating fair value for share-based payments requires management to determine the most appropriate valuation model for a grant, which is dependent on the terms and conditions of each grant. In valuing certain types of stock- based payments, such as incentive stock options and stock appreciation rights, the Company uses the Black- Scholes option pricing model. Several assumptions are used in the underlying calculation of fair values of the Company’s stock options and stock- appreciation rights using the Black-Scholes option pricing model, including the expected life of the option, stock- price volatility and forfeiture rates. (iv) Revenue Recognition: As is typical in the pharmaceutical industry, the Company’s royalty streams are subject to a variety of deductions that are generally estimates and recorded in the same period that the revenues are recognized and primarily represent rebates, discounts, incentives and product returns. These deductions represent estimates of the related obligations. Amounts recorded for sales deductions can result from a complex series of judgments about future events and uncertainties and can rely on estimates and assumptions. (v) Impairment of Non-financial Assets: The Company reviews the carrying value of non-financial assets for potential impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. However, goodwill and indefinite life intangible assets are tested for impairment annually at December 31st. The impairment test on cash-generating units (CGUs) is carried out by comparing the carrying amount of the CGU and its recoverable amount. The recoverable amount of a CGU is the higher of fair value, less costs to sell, and its value in use. This complex valuation process entails the use of methods, such as the discounted cash flow method, which requires numerous assumptions to estimate future cash flows. The recoverable amount is impacted significantly by the discount rate selected to be used in the discounted cash flow model, as well as the quantum and timing of expected future cash flows and the growth rate used for the extrapolation. Recent Accounting Pronouncements Accounting Standards Issued But Not Yet Applied Certain new standards, interpretations, amendments and improvements to existing standards were issued by the IASB or IFRS Interpretations Committee that are mandatory for fiscal periods beginning on or after January 1, 2018. The standards impacted that may be applicable to the Company are as follows: IFRS 9 - Financial Instruments In July 2014, the IASB issued IFRS 9 - Financial Instruments (IFRS 9), which will replace IAS 39 - Financial Instruments and all previous versions of IFRS 9. IFRS 9 establishes principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash flows. This new standard is effective for the Company’s interim and annual Consolidated Financial Statements commencing January 1, 2018. The Company has completed its assessment of the standard and does not anticipate significant changes to its current recognition policies. IFRS 15 - Revenue from Contracts with Customers In May 2014, the IASB issued IFRS 15 - Revenue from Contracts with Customers (IFRS 15), which covers principles for reporting about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. IFRS 15 is effective for annual periods beginning on or after January 1, 2018. The Company will transition applying the modified retrospective approach - i.e. by recognizing the cumulative effect of initially applying IFRS 15 as an adjustment to the opening balance of equity at January 1, 2018. The Company completed its assessment of all customer contracts in existence as at December 31, 2017, excluding contracts assumed from the Resultz acquisition (See Note 4, “Acquisition of Resultz Product and Intellectual Property Rights” of the Company’s Consolidated Financial Statements for the year ended December 31, 2017”). Based on this assessment, the Company does not anticipate significant adjustments to the opening balance of equity. Due to the timing of the Resultz acquisition, which closed on December 29, 2017, the Company is currently in the process of assessing the quantitative and qualitative implications of the customer contracts acquired under IFRS 15. IFRS 15 requires an entity to disclose additional quantitative and qualitative information about its contracts with customers; therefore, there will be significant changes to the Company’s financial statement disclosures. The Company will be providing more disaggregated information about revenue and additional disclosures about the Company’s remaining performance obligations as at the reporting date. Amendments to IFRS 2 - Share-based Payments In June 2016, the IASB issued amendments to IFRS 2 - Share-based Payments (IFRS 2), clarifying how to account for certain types of share-based payment transactions. The amendments provide requirements on the accounting for: the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments; share-based payment transactions with a net settlement feature for withholding tax obligations; and a modification to the terms and conditions of a share-based payment that changes the classification from cash-settled to equity- settled. The amendments to IFRS 2 are effective prospectively for annual periods beginning on or after January 1, 2018. The Company has completed its assessment of the standard and does not anticipate significant changes to its current recognition policies. IFRS 16 - Leases In January 2016, the IASB issued IFRS 16 - Leases (IFRS 16), its new leases standard that requires lessees to recognize assets and liabilities for most leases on their balance sheets. Lessees applying IFRS 16 will have a single accounting model for all leases, with certain exemptions. Lessor accounting is substantially unchanged. The new standard will be effective on or after January 1, 2019, with limited early application permitted. The Company is in the process of reviewing the standard to determine the impact on the Consolidated Financial Statements. Other accounting standards or amendments to existing accounting standards that have been issued, but have future effective dates, are either not applicable or are not expected to have a significant impact on the Company’s annual Consolidated Financial Statements. Management’s Responsibility for Financial Reporting Disclosure controls and procedures (DCP) are designed to provide reasonable assurance that information required to be disclosed by the Company in its filings under Canadian securities legislation is recorded, processed, summarized and reported in a timely manner. The system of DCP includes, among other things, the Company’s Corporate Disclosure and Code of Conduct and Business Ethics policies, the review and approval procedures of the Corporate Disclosure Committee and continuous review and monitoring procedures by senior management. Management is also responsible for the design of internal controls over financial reporting (ICFR) within the Company, in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. Due to its inherent limitations, DCP and ICFR may not prevent or detect all misstatements, errors and fraud. In addition, the design of any system of control is based upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all future events, no matter how remote or that the degree of compliance with the policies or procedures may not deteriorate. Accordingly, even effective DCP and ICFR can only provide reasonable, not absolute, assurance of achieving the control objectives for financial and other reporting. There were no material changes to the Company’s ICFR that occurred during the year ended December 31, 2017. Risk Factors Prospects for companies in the biotechnology and pharmaceutical industry generally may be regarded as uncertain given the nature of the industry and, accordingly, investments in biotechnology and pharmaceutical companies should be regarded as speculative. An investor should carefully consider the risks and uncertainties described below, as well as other information contained in this MD&A, in addition to the broader risk factors discussed in the Company’s AIF. The risks and uncertainties described below are not an exhaustive list. Additional risks and uncertainties not presently known to the Company or that the Company believes to be immaterial may also adversely affect the Company’s business. If any one or more of the following risks occur, the Company’s business, financial condition and results of operations could be seriously harmed. Further, if the Company fails to meet the expectations of the public market in any given period, the market price of the Company’s common shares could decline. Before making an investment decision, each prospective investor should carefully consider the risk factors set out below and those included in the AIF and other public documents. Economic Environment Economic conditions may limit the Company’s ability to access capital or may cause the Company’s suppliers to increase their prices, reduce their output or change their terms of sale. If the Company’s customers’ or suppliers’ operating and financial performance deteriorates or if they are unable to make scheduled payments or obtain credit, its customers may not be able to pay or may delay payment of accounts receivable owed and its suppliers may restrict credit or impose different payment terms. Any inability of customers to pay the Company for its products or any demands by suppliers for different payment terms, may adversely affect its earnings and cash flow. The Company has no control over changes in inflation and interest rates, foreign currency exchange rates and controls or other economic factors affecting its businesses or the possibility of political unrest, legal and regulatory changes in jurisdictions in which the Company operates. These factors could negatively affect the Company’s future results of operations in those markets. Dependence on Sales and Marketing Partnerships The Company has limited sales and marketing experience and lacks financial and other resources necessary to undertake marketing and advertising activities worldwide. Accordingly, the Company relies on marketing arrangements, including joint ventures, licensing or other third-party arrangements, to distribute its products in jurisdictions where it lacks the resources or expertise. The Company faces, and will continue to face, significant competition in seeking appropriate partners and distributors. Moreover, collaboration and distribution arrangements are complex and time consuming to negotiate, document and implement. Therefore, there can be no assurance that the Company will be able to find additional marketing and distribution partners in any jurisdiction or be able to enter into any marketing and distribution arrangements on any terms, acceptable or not. Moreover, there can be no assurance that its partners will dedicate the resources needed to successfully market and distribute the Company’s products and maximize sales. In addition, under these arrangements, disputes may arise with respect to payments that the Company or its partners believe are due under such distribution or marketing arrangements, a partner or distributor may develop or distribute products that compete with the Company’s products or they may terminate the relationship. The Company has no influence in sales and marketing activities for Pennsaid 2% and Pennsaid in the markets in which they are currently available. Decisions impacting sales and marketing efforts are made by the Company’s partners for their respective territories. If one of the Company’s partners is unable to successfully sell or stops selling its respective product, for any reason, it could have an adverse effect on the Company’s product sales and cash resources, as well as royalties earned in Canada. The Company has licensed the rights for the HLT Patch to Galen for the U.S. and Eurocept for the E.U. and certain other territories and has no influence on sales and marketing activities for this product in the licensed territories. The Company depends on all of its partners and licensees to comply with all government legislation and regulations relating to selling the Company’s products in their respective territories. If any of the Company’s partners do not comply, this could materially adversely impact the cash flows of the Company. Dependency on Horizon The Company currently derives substantially all of its revenue from Pennsaid 2% U.S. commercial bottle and sample product sales to Horizon pursuant to a long-term, exclusive supply agreement. It is possible that quarterly and annual results of operations will be impacted for the foreseeable future by Horizon’s demand for Nuvo’s Pennsaid 2% products which is a function of Horizon’s management strategies and inventory levels, as well as U.S. market demand for commercial product. If Horizon was unable to successfully sell or reduces or stops sampling or selling Pennsaid 2%, for any reason, it could materially adversely impact the Company’s product sales and cash resources. Horizon indicated in its Q1 2017 disclosures that it had been experiencing some reimbursement and pricing pressures from insurance companies for its primary care products, including Pennsaid 2%, which had reduced the profitability of that portion of its business. Due to its primary care group’s decreased profitability, Horizon noted that it is reallocating resources to better align its costs and profits. This reallocation of resources included a reduction in its primary care sales force. The Company expects Horizon’s cost reallocation initiatives to also result in a decrease in the number of product samples Horizon distributes to physicians. A reduction in sample product orders from Horizon will have a negative impact on the Company’s future financial results. For several weeks during 2017, our manufacturing facility in Varennes, Québec did not produce any commercial bottles of Pennsaid 2% for Horizon. This was part of a plan developed with Horizon to install new Pennsaid 2% packaging equipment and software systems. The new equipment was required to put Nuvo and Horizon in compliance with new DSCSA rules that mandate all manufacturers of drug products sold in the U.S. to serialize each individual package to enhance drug traceability in the event of an adverse event and to prevent drug counterfeiting. During this period of reduced production, Horizon was drawing non-serialized inventory of Pennsaid 2% commercial bottles that we had previously shipped to them. On June 30, 2017, the FDA announced that it was extending the serialization compliance date by one year - from November 17, 2017 to November 17, 2018. As a result of this change, Horizon requested that we deliver non-serialized commercial bottles to them before we completed the equipment and software qualification process. The Company completed its qualification and was fully compliant with the DSCSA rules during the fourth quarter. If product sales to Horizon do not increase now that the Company’s serialization equipment is operational, the Company’s sales, earnings and cash flow will be negatively impacted. Generic Drug Manufacturers Regulatory approval for competing generic drugs can be obtained without investing in the same level of costly and time-consuming clinical trials that the Company has conducted or might conduct in the future. Due to the substantially reduced development costs, generic drug manufacturers are often able to charge much lower prices for their products than the original developer. The Company faces competition from manufacturers of generic drugs on some of its products that are commercial, since a number of the Company’s patents have expired, or if not yet expired, may be ignored by generic drug manufacturers who choose to launch their products “at risk” of a possible patent infringement lawsuit brought by the Company or its licensing partners. Generic competition may impact the prices at which the Company’s products are sold, the royalty rates the Company receives and the volume of product sold which may substantially reduce the Company’s overall revenues. The Company’s partner in Canada has launched an authorized generic version of Pennsaid to compete with the generic version of Pennsaid and protect market share. The Company earns revenue in the form of product sales to Paladin and a royalty on Canadian net sales of the generic. In February 2014, Taro Pharmaceutical Industries, Ltd. received approval in Canada for a generic version of Pennsaid which they launched in March 2014. This generic impacted the net sales that Paladin earns from Pennsaid, thereby reducing the Company’s royalty income. There are currently five generic versions of Pennsaid approved in Canada, including the authorized generic. Three of the generics have launched. In the U.S., under the Hatch-Waxman Act, the FDA can approve an Abbreviated New Drug Application (ANDA) for a generic version of a branded drug or a variation of an existing branded drug, without undertaking the clinical testing necessary to obtain approval to market a new drug. This is referred to as the “ANDA process”. In place of such clinical studies, an ANDA applicant usually needs to submit data and information demonstrating that its product has the same active ingredient(s) and is bioequivalent to the branded product, in addition to, for example, any data necessary to establish that any difference in inactive ingredients does not result in different safety or efficacy profiles, as compared to the reference drug. The Hatch-Waxman Act, in addition to providing brand-name drug manufacturers with periods of marketing exclusivity, such as three-year “new clinical investigation” exclusivity, requires an applicant for a drug that relies, at least in part, on the FDA’s findings of safety or effectiveness for a branded drug, to notify the sponsor of the branded drug of their application and potential infringement of any patents listed in the FDA Orange Book. Upon receipt of this notice, the sponsor of the branded drug has 45 days to bring a patent infringement suit in federal district court against the applicant seeking approval of a product covered by the patent. If such a suit is commenced and the ANDA was filed after the patent had been listed in the FDA Orange Book, then the FDA is generally prohibited from granting approval of the ANDA or Section 505(b)(2) NDA, a type of NDA that relies on information for which the applicant does not have a right of reference, until the earliest of 30 months from the date the FDA accepted the application for filing (the 30-Month Stay), or the conclusion of patent infringement litigation in the generic’s favour or expiration of the patent. If an ANDA was filed before the patent had been listed in the FDA Orange Book, the 30-Month Stay does not apply and it is possible that the ANDA holder may launch its generic product “at risk” of patent infringement proceedings initiated by the innovator drug company. If the litigation is resolved in favour of the applicant or the challenged patent expires during the 30-month stay period, the stay is terminated and the FDA may thereafter approve the application based on the standards for approval of ANDAs and Section 505(b)(2) NDAs. Frequently, the unpredictable nature and significant costs of patent litigation leads the parties to settle out of court. Settlement agreements between branded companies and generic applicants may allow, among other things, a generic product to enter the market prior to the expiration of any or all of the applicable patents covering the branded product, either through the introduction of an authorized generic or by providing a license to the patents in suit. In the U.S., Pennsaid 2% is protected by multiple patents listed in the FDA Orange Book (Pennsaid 2% Orange Book Patents) and received 3-year exclusivity under the Hatch-Waxman Act. All of the intellectual property for Pennsaid 2% for the U.S. is owned by Horizon and it is their responsibility to litigate any claims against these patents from generic companies. Patent litigation is currently pending in the United States District Court for the District of New Jersey against several companies intending to market a generic version of Pennsaid 2% prior to the expiration of certain Pennsaid 2% Orange Book Patents. These cases involve the following sets of defendants: (i) Actavis Laboratories UT, Inc., formerly known as Watson Laboratories, Inc., Actavis, Inc. and Actavis plc; and (ii) Lupin Limited and Lupin Pharmaceuticals, Inc. Horizon Pharma Ireland Limited, et al v. Actavis Laboratories UT, Inc., C.A. No. 14-cv-7992-NLH-AMD, a bench trial was held in March 2017. In May 2017, the United States District Court for the District of New Jersey upheld the validity of one of the claims in one of Horizon’s U.S. patent covering Pennsaid 2%. Actavis Laboratories UT, Inc. has appealed this decision. No trial date has been set in any other pending Pennsaid 2% cases. The approval or launch of generic versions of Pennsaid 2% in the U.S. market could materially adversely impact the Company’s future revenue from product sales. Obtaining Government and Regulatory Approvals The research, testing, manufacturing, packaging, labeling, approval, storage, selling, marketing and distribution of drug products are subject to extensive regulation in the U.S. by the FDA, in Canada by the TPD and by similar regulatory authorities in the E.U., Japan and elsewhere, and regulations and requirements differ from country-to- country. Despite the time and expense exerted by the Company, failure can occur at any stage. The process of completing a drug development program and obtaining regulatory approval for a drug can be long and may involve significant delays despite the Company’s best efforts and can require substantial cash and people resources. Even after initial approval has been obtained, further research, including post-marketing studies, may be required to expand indications covered under the product approvals and labelling. Also, regulatory agencies require post-marketing surveillance programs to monitor side effects. Results of post-marketing programs may limit or expand additional marketing of the drug. Moreover, regulations are rigorous, time consuming and costly and the Company cannot predict the extent to which it may be affected by changes in regulatory developments and its ability to meet such regulations. There is also a risk that the Company’s products may be withdrawn from the market and the required approvals suspended as a result of non-compliance with regulatory requirements. Furthermore, there can be no assurance that the regulators will not require modification to any submissions, which may result in delays or failure to obtain regulatory approvals. Any delay or failure to obtain regulatory approvals could adversely affect the Company’s business, financial condition and operational results. Further, there can be no assurance that the Company’s products will prove to be safe and effective in clinical trials or receive the requisite regulatory approval in any market. In addition to the regulatory product approval framework, pharmaceutical companies are subject to a number of other regulations covering occupational safety, laboratory practices, environmental protection and hazardous substance control. They may also be subject to existing and future local, provincial, state, federal and foreign regulation, including possible future regulation of the overall industry. Failure to obtain necessary regulatory approvals, the restriction, suspension or revocation of existing approvals or any other failure to comply with regulatory requirements, could materially adversely impact the Company’s business, financial condition and operational results. United States Regulation The FDA has substantial discretion in the drug approval process. The FDA may delay, limit or deny approval of a drug candidate for many reasons including: • a drug candidate may not be deemed safe or effective; • • • the FDA may find the data from preclinical studies, CMC and clinical trials insufficient; the FDA may change its approval policies or adopt new regulations; or third-party products may enter the market and change approval requirements. Even once drug candidates are approved, these approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems occur after the product reaches the market. The FDA may require further testing and surveillance programs to monitor the pharmaceutical product that has been commercialized. Non- compliance with applicable requirements can result in fines and other judicially imposed sanctions, including product seizures, injunction actions and criminal prosecutions. The process of receiving FDA approval has become more difficult with the requirement to submit a Risk Evaluation and Mitigation Strategy (REMS) as part of the drug application for certain classes of drugs and some individual drug products. In addition, the FDA may require REMS after approving a covered application, including applications approved before the REMS program was initiated. In addition, the FDA has the authority to regulate the claims the Company’s partners make in marketing its prescription drug products to ensure that such claims are true, not misleading, supported by scientific evidence and consistent with the product’s approved labelling. Failure to comply with FDA requirements in this regard could result in, among other things, suspensions or withdrawal of approvals, product seizures and injunctions against the manufacture, holding, distribution, marketing and sale of a product, civil and criminal sanctions. Canada Regulation The TPD may deny issuance of a NOC for an NDS if applicable regulatory criteria are not satisfied or may require additional testing. Product approvals may be withdrawn if compliance with regulatory standards is not maintained or if problems occur after the product reaches the market. The TPD may require further testing and surveillance programs to monitor a pharmaceutical product which has been commercialized. Non-compliance with applicable requirements can result in fines and other judicially imposed sanctions, including product seizures, injunction actions and criminal prosecutions. Additional Regulatory Considerations There is no assurance that problems will not arise that could delay or prevent the commercialization of the Company’s products currently under development or that the TPD, FDA or other foreign regulatory agencies will be satisfied with the information submitted by the Company, including results of clinical trials, to approve the marketing of such products. In addition to the regulatory approval process, pharmaceutical companies are subject to regulations under local, provincial, state and federal law, including requirements regarding occupational safety, laboratory practices, environmental protection and hazardous substance control and may be subject to other present and future local, provincial, state, federal and foreign regulations, including possible future regulations of the pharmaceutical industry. The Company cannot predict the time required for regulatory approval or the extent of clinical testing and documentation that is required by regulatory authorities. Any delays in obtaining, or failure to obtain regulatory approvals in Canada, the U.S., the E.U. or other foreign countries, would significantly delay the development of the Company’s markets and the receipt of revenues from the sale of its products. Changes in Government Regulation The business of the Company may be adversely affected by such factors as changes in the regulatory environment with respect to intellectual property, regulation, export controls, import controls, tariffs and taxes or product marketing approvals. Such changes remain beyond the Company’s control and have an unpredictable impact. Risks Related to Unexpected Product Safety or Efficacy Concerns Unexpected safety or efficacy concerns can arise with respect to marketed products, whether or not scientifically justified, leading to product recalls, withdrawals or declining sales, as well as potential product liability, consumer fraud or other claims. Any of such occurrences could materially adversely impact the Company’s business, financial condition and results of operations. Manufacturing and Supply Risks The Company purchases key raw materials necessary for the manufacture of its products and finished products from a limited number of suppliers around the world and in some cases relies on its licensing partners to manufacture its products. In the case of Pennsaid 2% and Pennsaid, the Company has a supply agreement with a single supplier based in the U.S. to purchase all of the Company’s requirements for pharmaceutical grade DMSO (one of the key ingredients in Pennsaid 2% and Pennsaid) until December 31, 2022 using the supplier’s patented process. It may be difficult to find another manufacturer if the supplier is unable to supply the Company with a sufficient amount of DMSO or if the Company is forced for any other reason to find another supplier. It could take another supplier a significant period of time to develop and certify the necessary processes to manufacture the product on terms acceptable to the Company or the related regulatory authority. There may not be suppliers who are able to meet the Company’s volume or quality requirements at a price that is as favourable as the current supplier. Any operating, production or quality problems experienced by these suppliers that result in a reduction or interruption in supply could significantly delay the manufacture and sale of the Company’s products. If the relationships with any of the single-sourced suppliers is discontinued or if any manufacturer is unable to supply or produce required quantities of product on a timely basis, or at all, or if a supplier ceases production of an ingredient or component, the operations would be negatively impacted and the business would be harmed. For the HLT Patch, Galen and Eurocept are responsible for manufacturing the patch and both rely on the same CMO in the U.S. The Company does and will depend on Galen and Eurocept to ensure the CMO remains a qualified supplier of the product for all global markets and will have limited ability, if any, to control the manufacturing process. The HLT Patch also contains the active drugs lidocaine and tetracaine and in the past, the form of tetracaine used in the product has, at times, been difficult to procure. The Company is reliant on Galen and Eurocept to ensure that the CMO maintains the facility at which it manufactures the HLT Patch in compliance with FDA, EMA, state and local regulations and other regulatory agencies. If the CMO fails to maintain compliance with FDA, EMA or other critical regulations, they could be ordered to cease manufacturing which could materially adversely impact the Company’s business, results of operations, financial condition and cash flows. In addition to FDA regulations, violation of standards enforced by the United States Environmental Protection Agency, the Occupational Safety and Health Administration, and their counterpart agencies at the state level, could slow down or curtail operations of the CMO. For Resultz, the Company’s current license partners, Reckitt Benckiser, Aralez, Lapidot and Takeda, are all responsible for manufacturing the product and rely on either CMOs or their own internal manufacturing to supply their needs. The Company depends on these license partners to ensure their internal manufacturing or external CMOs remain qualified suppliers of the Resultz for the respective markets and Nuvo will have limited ability, if any, to control the manufacturing process. The Company is reliant on the license partners to ensure that the CMOs or license partners maintain the facilities where Resultz is manufactured in compliance with FDA, EMA, state and local regulations and other regulatory agencies. If the CMOs or license partners fail to maintain compliance with FDA, EMA or other critical regulations, they could be ordered to cease manufacturing which could materially adversely impact the Company’s business, results of operations, financial condition and cash flows. In addition, the FDA and other regulatory agencies require that raw material manufacturers comply with all applicable regulations and standards pertaining to the manufacture, control, testing and use of the raw materials as appropriate. For the Active API or critical raw materials depending on the drug product, this means compliance to current GMPs for APIs and submission of all data related to the manufacture, control and testing of the API for quality, purity, identity and stability, as well as a complete description of the process, equipment, controls and standards used for the production of the API. This is usually submitted to the FDA in the form of a Drug Master File (DMF) by the manufacturer and referenced by the sponsor of the NDA. The DMF information and data is reviewed by the FDA as a critical component of the approvability of the NDA. As a result, in the case where only one supplier of a particular API or critical raw material meets all of the FDA’s (or other regulatory agencies) requirements and has a DMF (or similar filing) on file with the FDA, the Company is at risk should a supplier violate GMP, fail an FDA inspection, terminate access to its DMF, be unable to manufacture product, choose not to supply the Company or decide to increase prices. For DMSO and tetracaine, the Company has only one approved supplier for all jurisdictions in which Pennsaid and the HLT Patch has been approved. For Pennsaid 2% and Pennsaid’s API, diclofenac sodium, the Company has two approved suppliers for Canada, the E.U. and the U.S. For some of the Company’s other raw materials required to manufacture Pennsaid 2%, Pennsaid, Resultz and the bulk substance for the HLT Patch, the Company currently has only one approved supplier. However, in the case of Resultz, all of the critical raw materials used in the manufacture of the product are currently commercially available from more than one supplier. In addition, the Company could be subject to various import duties applicable to both finished products and raw materials and it may be affected by other import and export restrictions, as well as developments with an impact on international trade. Under certain circumstances, these international trade factors could affect manufacturing costs, which will in turn, affect the Company’s margins, as well as the wholesale and retail prices of manufactured products. The Company’s current internal manufacturing capabilities are limited to its site in Varennes, Québec, which is the sole manufacturing site of Pennsaid 2%, Pennsaid and the bulk drug product for the HLT Patch for all markets. The Company has never achieved full capacity utilization in this facility. This exposes the Company to the following risks, any of which could delay or prevent the commercialization of its products, result in higher costs or deprive it of potential product revenues: • The Company may encounter difficulties in achieving volume production, quality control and quality assurance, as well as relating to shortages of qualified personnel. Accordingly, the Company might not be able to manufacture sufficient quantities to meet its clinical trial needs or to commercialize its products; • The Company’s manufacturing facilities are required to undergo satisfactory current GMP inspections prior to regulatory approval and are obliged to operate in accordance with FDA, E.U. and other nationally mandated GMP, which govern manufacturing processes, stability testing, record keeping and quality standards. Failure to establish and follow GMPs and to document adherence to such practices, may lead to significant delays in the availability of material for clinical studies and may delay or prevent filing or approval of marketing applications for the Company’s products; and • Changing manufacturing locations would be difficult and the number of potential manufacturers is limited. Changing manufacturers generally requires re-validation of the manufacturing processes and procedures in accordance with FDA, E.U. and other nationally mandated GMPs. Such re- validation may be costly and would be time consuming. It would be difficult or impossible to quickly find replacement manufacturers on acceptable terms, if at all. The Company’s manufacturing facilities are subject to ongoing periodic unannounced inspection by the FDA and corresponding agencies, including E.U. and Canadian agencies, and may be subject to inspection by local, state, provincial and federal authorities from various jurisdictions to ensure strict compliance with GMPs and other government regulations. Failure by the Company to comply with applicable regulations could result in sanctions being imposed on it, including fines, injunctions, civil penalties, failure of the government to grant review of submissions or market approval of drugs, delays, suspension or withdrawal of approvals, seizures or recalls of product, operating restrictions, facility closures and criminal prosecutions, any of which could materially adversely impact the Company’s business. The Company may encounter manufacturing failures that could impede or delay commercial production of its products. Any failure in the Company’s manufacturing operations could cause the Company to be unable to meet the demand for its products and lose potential revenue and harm its reputation. The Company’s manufacturing operations may encounter difficulties involving, among other things, production yields, regulatory compliance, quality control and quality assurance and shortages of qualified personnel. Impact of demand fluctuations outside our ability to control or influence In general, the Company’s marketing partners are required to provide 12 to 24-month rolling forecasts of their demand on a quarterly basis, and are also required to place firm purchase orders based on the near-term portion of those forecasts. If wholesaler or market demand for these products is lower than forecasted, the Company’s marketing partners or their wholesaler customers may accumulate excess inventory. If such conditions persist, the Company’s marketing partners may sharply reduce subsequent purchase orders for a sustained period of time until such excess inventory is consumed, if ever. Significant and unplanned reductions in our manufacturing orders have occurred in the past and the Company’s results of operations were adversely affected. If such reductions occur again in the future, the Company’s revenues will be negatively impacted, economies of scale will be lost, and revenues may be insufficient to fully absorb overhead costs, which could result in net losses. Conversely, if the Company’s marketing partners promote significantly increased demand, the Company may not be able to manufacture such unplanned increases in a timely manner, especially following prolonged periods of reduced demand. As the Company has no control over these factors, purchase orders could fluctuate significantly from quarter-to-quarter, and the results of operations could fluctuate accordingly. Impact of natural disasters or other events that disrupt our business operations Nuvo’s manufacturing facilities are located in Varennes, Québec, where natural disasters or similar events, like blizzards, fires or explosions or large-scale accidents or power outages, could severely disrupt our operations, and materially adversely impact our business, results of operations, financial condition and prospects. If a disaster, power outage or other event occurred that prevented Nuvo from using all or a significant portion of this facility, that damaged critical infrastructure or that otherwise disrupted operations, it may be difficult or, in certain cases, impossible for Nuvo to continue our business for a substantial period of time. Patents, Trademarks and Proprietary Technology There can be no assurance as to the breadth or degree of protection that existing or future patents or patent applications may afford the Company or that any patent applications will result in issued patents or that the Company’s patents or trademarks will be upheld if challenged. It is possible that the Company’s existing patent or trademark rights may be deemed invalid. Although the Company believes that its products do not, and will not, infringe valid patents or trademarks or violate the proprietary rights of others, it is possible that use, sale or manufacture of its products may infringe on existing or future patents, trademarks or proprietary rights of others. If the Company’s products infringe the patents or proprietary rights of others, the Company may be required to stop selling or making its products, may be required to modify or rename its products or may have to obtain licenses to continue using, making or selling them. There can be no assurance that the Company will be able to do so in a timely manner, upon acceptable terms and conditions, or at all. The failure to do any of the foregoing could materially adversely impact the Company. In addition, there can be no assurance that the Company will have sufficient financial or other resources to enforce or defend a patent infringement or proprietary rights violation action. Moreover, if the Company’s products infringe patents, trademarks or proprietary rights of others, the Company could, under certain circumstances, become liable for substantial damages which could materially adversely impact the Company. Regardless of the validity of the Company’s patents, there can be no assurance that others will be unable to obtain patents or develop competitive non-infringing products or processes that permit such parties to compete with the Company. The Company may not be able to protect its intellectual property rights throughout the world as filing, prosecuting and defending patents and trademarks on all of the Company’s product candidates, products and product names, when and if they exist, in every jurisdiction would be prohibitively expensive and can take several years. Competitors may manufacture, sell or use the Company’s technologies and use its trademarks in jurisdictions where the Company or its partners have not obtained patent and trademark protection. These products may compete with the Company’s products, when and if it has any, and may not be covered by any of its or its partners’ patent claims or other intellectual property rights. The laws of some countries do not protect intellectual property rights to the same extent as the laws of Canada and the U.S. and many companies have encountered significant problems in protecting and defending such rights in foreign jurisdictions. The legal systems of certain countries, particularly certain developing countries, do not favour the enforcement of patents, trademarks and other intellectual property protection, particularly those protections relating to biotechnology and pharmaceuticals, which could make it difficult for the Company to stop the infringement of its patents. Proceedings to enforce patent rights in foreign jurisdictions could result in substantial cost and divert efforts and attention from other aspects of the business. The discovery, trial and appeals process in patent litigation can take several years. Should the Company commence a lawsuit against a third party for patent infringement or should there be a lawsuit commenced against the Company with respect to the validity of its patents or any alleged patent infringement by the Company, the cost of such litigation, as well as the ultimate outcome of such litigation, if commenced, whether or not the Company is successful, could materially adversely impact its business, results of operations, financial condition or cash flows. Inability to Achieve Drug Development Goals within Expected Time Frames From time-to-time, the Company sets targets and makes public statements regarding its expected timing for achieving drug development goals. These include targets for the commencement and completion of preclinical and clinical trials, studies and tests and anticipated regulatory filing and approval dates. These targets are set based on a number of assumptions that may not prove to be accurate. The actual timing of these forward-looking events can vary dramatically from the Company’s estimates or they might not be achieved at all, due to factors such as delays or failures in clinical trials or preclinical work, scheduling changes at Contract Research Organizations (CROs), the need to develop additional data required by regulators as a condition of approval, the uncertainties inherent in the regulatory approval process, delays in achieving manufacturing or marketing arrangements necessary to commercialize product candidates and limitations on the funds available to the Company. If the Company does not meet these targets, including those which are publicly announced, the ultimate commercialization of its products may be delayed and, as a result, its business could be harmed. Also, there can be no assurance that such trials and studies will be sufficient for regulatory authorities or that the required regulatory approvals will be obtained. Uncertainty of Drug Research and Development There can be no assurance that any of the Company’s product candidates will be successfully developed in a timely manner or that they will prove to be more effective than products based on existing or new technologies or that a sufficient number of medical professionals will recommend their use. The risk that a product candidate may fail clinical trials, the Company may be unable to successfully complete development or a decision for financial or other reasons to halt development of any product candidate, particularly in instances where significant capital expenditures have already been made, could materially adversely impact the Company. There can be no assurance that preclinical or clinical testing of the Company’s product candidates will yield sufficiently positive results to enable progress toward commercialization and any such trials will take significant time to complete. Unsatisfactory results may prompt the Company to reduce or abandon future testing or commercialization of particular product candidates and this could materially adversely impact the Company. Due to the inherent risk associated with R&D efforts in the pharmaceutical industry, particularly with respect to new drugs, the Company’s R&D expenditures may not result in the successful introduction of government approved new pharmaceutical products. Also, after submitting a drug candidate for regulatory approval, the regulatory authority may require additional studies, and as a result, the Company may be unable to reasonably predict the total R&D costs to develop a particular product. Risk Related to Clinical Trials The Company and its drug development partners must demonstrate, through preclinical studies and clinical trials, that the product being developed is safe and efficacious before obtaining regulatory approval for the commercial sale of such product. The results of preclinical studies and previous clinical trials are not necessarily predictive of future results and the Company’s current product candidates may not have favourable results in later testing or trials. Preclinical tests and Phase 1 and Phase 2 clinical trials are primarily designed to test safety, to study PK and pharmacodynamics and to understand the side effects of products at various doses and schedules. Success in preclinical or animal studies and early clinical trials does not ensure that later large-scale efficacy trials will be successful and such success is not necessarily predictive of final results. Favourable results in early trials may not be repeated in later trials and positive interim results do not ensure success in final results. Even after the completion of Phase 3 clinical trials, the FDA, TPD, EMA or other regulatory authorities may disagree with the clinical trial design and interpretation of data and may require additional clinical trials to demonstrate the efficacy of product candidates. A number of companies in the biotechnology and pharmaceutical industry have suffered significant setbacks in advanced clinical trials, even after achieving promising results in earlier trials and preclinical studies. The Company suffered a similar setback with the results of its 2016 Pennsaid 2% ankle sprain Trial. In many cases where clinical results were not favourable, were perceived negatively or otherwise did not meet expectations, the share prices of these companies declined significantly. Failure to complete clinical trials successfully and to obtain successful results on a timely basis could have an adverse effect on the Company’s future business and its common share price Reliance on Third Parties to Conduct Clinical and Preclinical Studies The Company and its drug development partners rely on third parties such as CROs, medical institutions and clinical investigators to enroll qualified patients, conduct, supervise and monitor its clinical trials, conduct preclinical studies and complete CMC work. The reliance on these third parties for clinical development activities reduces its control over these activities. The reliance on these third parties; however, does not relieve the Company or its drug development partners of their regulatory responsibilities, including ensuring that its clinical trials are conducted in accordance with GCPs and that its preclinical studies are conducted in accordance with GLPs. Furthermore, these third parties may have relationships with other entities, some of which may be competitors. In addition, they may not complete activities on schedule or may not conduct preclinical studies or clinical trials in accordance with regulatory requirements or the Company’s trial design. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, the Company’s ability to obtain regulatory approvals for product candidates may be delayed or prevented. Competition The pharmaceutical industry is characterized by evolving technology and intense competition. The Company is engaged in areas of research where developments are expected to continue at a rapid pace. Many companies, including major pharmaceutical and specialized biotechnology companies, are engaged in activities focused on medical conditions that are the same as or similar to those targeted by the Company. The Company’s success depends upon maintaining its competitive position in the R&D and commercialization of its products. Competition from pharmaceutical, chemical and biotechnology companies, as well as universities and research institutes, is intense and is expected to increase. Many of these organizations have substantially greater R&D, experience in manufacturing, marketing, financial and managerial resources and they represent significant competition. If the Company fails to compete successfully in any of these areas, its business, results of operations, financial condition and cash flows could be adversely affected. The intensely competitive environment of the branded products business requires an ongoing, extensive search for medical and technological innovations and the ability to market products effectively, including the ability to communicate the effectiveness, safety and value of branded products for their intended uses to healthcare professionals in private practice, group practices and managed care organizations. There can be no assurance that the Company and its drug development partners will be able to successfully develop medical or technological innovations or that the Company and its licensing partners will be able to effectively market the Company’s existing products or any future products. The Company’s branded products may face competition from generic versions. Generic versions are generally significantly cheaper than the branded version, and, where available, may be required or encouraged in preference to the branded version under third-party reimbursement programs or substituted by pharmacies for branded versions by law. The entrance of generic competition to the Company’s branded products generally reduces the market share and adversely affects the Company’s profitability and cash flows. Generic competition with the Company’s branded products could materially adversely impact the Company’s sales and profitability. Additionally, the Company competes to acquire the intellectual property assets that are required to continue to broaden its product portfolio. The Company seeks to acquire rights to new intellectual property through corporate acquisitions, asset acquisitions, licensing and joint venture arrangements. Competitors with greater resources may acquire assets that the Company seeks, and even if the Company is successful, competition may increase the acquisition price of such assets. If the Company fails to compete successfully, its growth may be limited. Competition for Pennsaid 2% and Pennsaid Several major pharmaceutical companies have developed oral COX-2 selective NSAIDs designed to reduce gastrointestinal side effects associated with other types of NSAIDs. Some of these products have been taken off the market or drug development has stopped in response to safety concerns. Those that remain represent competition for market share. While the Company believes that topical administration gives Pennsaid 2% and Pennsaid a better safety profile than all oral NSAIDs, including those with PPIs and COX-2 selective medications, it may be subject to regulations and regulatory decisions of governing bodies, such as the FDA in the U.S., including label warnings that apply to NSAIDs generally or diclofenac specifically. Pennsaid 2% faces competition in the U.S. from at least two other topically applied diclofenac drug products available by prescription that were approved for marketing by the FDA, as well as numerous OTC products. The FLECTOR Patch, which contains the NSAID diclofenac epolamine was approved by the FDA for the topical treatment of acute pain due to minor strains, sprains and contusions and is marketed by Pfizer Inc. The second drug product, GSK’s Voltaren Gel which contains the NSAID diclofenac sodium was approved by the FDA for the relief of the pain of OA of joints amenable to topical treatment, such as the knees and those of the hand and is marketed by Endo Pharmaceuticals Inc. Both of these topical products have achieved respectable sales levels and they provide significant competition for market share. If patients and practitioners believe these competing products provide pain relief, it may be difficult for our partner to convince them to use Pennsaid 2%. Conversely, if they do not believe that they provide pain relief, this may create a perception that all topically applied products have similar efficacy, making it more difficult to convince physicians and their patients of the value of Pennsaid 2%. In Canada, there are five generic versions of Pennsaid approved in the market. The first generic was launched in 2014. In addition, our partner launched an authorized generic to protect market share. The launch of these generic versions of Pennsaid had an adverse impact on the Company’s revenue from Canada. A topical diclofenac product, GSK’s Voltaren Emulgel (1.16% w/w diclofenac diethylamine) has been available in Canada as an OTC since October 2008. In August 2014, Voltaren Emulgel Extra Strength (2.32% w/w diclofenac diethylamine) was approved in Canada as an OTC product and was launched by GSK in October 2014. In the E.U., several major pharmaceutical companies market oral and topical NSAIDs that compete against Pennsaid in countries where it is marketed. In addition to recently approved products, there may be other companies that are developing other products to treat the pain caused by OA, including topical NSAID products for the U.S. and other markets that may present additional competition in the future. Like Pennsaid 2% and Pennsaid, these drugs may be efficacious yet reduce the incidence of some of the side effects associated with traditional oral NSAIDs. The impact of competitive branded products and generic products could have a significant adverse effect on Pennsaid 2% product sales in the U.S. market, as well as the resulting level of royalties earned and product sales in Canada from Pennsaid sales. Competition for Resultz Resultz faces competition in all markets from other topically applied head lice solutions such as pesticide-based products (including pyrethrin, permethrin, malathion etc.), non-pesticide-based products (including dimethicone or other siloxanes) and homeopathic remedies (including tea tree oil, coconut oil and other naturally sourced ingredients). Key pesticide-based brands are Rid (Bayer), Nix (Prestige Brands), Sklice (Arbor), and Ovide (Taro). Key non- pesticide brands are Nix Ultra (Prestige Brands), Nyda (Pohl Boshkamp), Hedrin (Stada), Linicin (Meda) and Paranix (Omega). Key homeopathic remedies are Vamousse (TyraTech). The impact of present or future competitive branded prescription or OTC products could have a significant adverse effect on Resultz product sales in global markets. Competition for the HLT Patch The HLT Patch faces competition in all markets from other topically applied local anaesthetic drug products such as compounded anaesthetic creams that are available from certain pharmacies, EMLA Cream (a eutectic mixture of lidocaine 2.5% and prilocaine 2.5%), and L.M.X 4 and L.M.X.5 Anorectal Creams that are available OTC. Products May Fail to Achieve Market Acceptance Any products successfully developed, acquired or licensed by the Company may not achieve market acceptance and, as a result, may not generate significant revenues. Market acceptance of the Company’s products by physicians or patients will depend on a number of factors, including: • availability, cost and effectiveness of products when compared to competing products and alternative treatments; relative convenience and ease of administration; the prevalence and severity of any adverse side effects; the acceptance of competing products; • • • • pricing, which may be subject to regulatory control; • effectiveness of marketing and distribution partners’ sales and marketing strategies; and • the ability to obtain sufficient third-party insurance coverage or reimbursement. If any product commercialized by the Company does not provide a treatment regimen that is as beneficial as the current standard of care or otherwise does not provide patient benefit, there is the potential that it will not achieve market acceptance. This may result in a shortfall in revenues and an inability to achieve or maintain profitability. Publications of Negative Study or Clinical Trial Results The publication of negative results of studies or clinical trials related to the Company’s products, or the therapeutic areas in which its products compete, may adversely affect sales, the prescription trends for the products, the reputation of the products and the price of the Company’s common shares. From time-to-time, studies or clinical trials on various aspects of pharmaceutical products are conducted by the Company, academics or others, including government agencies. The results of these studies or trials, when published, may have a dramatic effect on the market for the pharmaceutical product that is the subject of the study. In the event of the publication of negative results of studies or clinical trials related to the Company’s marketed products or the therapeutic areas in which these products compete, the business, financial condition, results of operations and cash flows of the Company may be adversely affected. Reimbursement and Product Pricing There can be no assurance that Pennsaid 2%, Pennsaid, Resultz or the HLT Patch will be successfully commercialized in current markets or that the additional regulatory approvals necessary to commercialize Pennsaid 2%, Pennsaid, Resultz and the HLT Patch in markets where they are not currently approved will be obtained. In Canada, private health coverage insurers have generally approved reimbursement of Pennsaid costs, but government health authorities have not approved such reimbursement. Obtaining reimbursement approval for a product from each government or other third-party payer is a time consuming and costly process that could require the Company to provide supporting scientific, clinical and cost effectiveness data for the use of its products to each payer. In certain territories, this process is the responsibility of the licensee and the Company will have little financial impact from this process except to the extent the licensees are forced to provide significant discounts or rebates which would affect the level of net sales of the product and reduce the amount of royalties the Company earns. The Company may not have or be able to provide data sufficient to gain acceptance with respect to reimbursement. Even when a payer determines that a product is eligible for reimbursement, they may impose coverage limitations that preclude payment for some approved uses or that full reimbursement may not be available for the Company’s products. Furthermore, even after approval for reimbursement for the Company’s products is obtained from private health coverage insurers or government health authorities, it may be removed at any time. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products and there can be no assurance that third- party coverage will be sufficient to give the Company an appropriate return on its investment in developing existing or new products. Increasingly, government and other third-party payers are attempting to contain expenditures for new therapeutic products by limiting or refusing coverage, limiting reimbursement levels, imposing high co-pays, requiring prior authorizations and implementing other measures. Inadequate coverage or reimbursement could adversely affect market acceptance of the Company’s products. Third-party payers increasingly challenge the pricing of pharmaceutical products. Moreover, the trend toward managed healthcare in the U.S., the growth of organizations such as health maintenance organizations and reforms to healthcare and government insurance programs, could significantly influence the purchase of healthcare services and products, resulting in lower prices and reduced demand for the Company’s products. In the U.S., each third-party payer plan is organized into tiers and the number of tiers will vary. Each tier represents a different reimbursement level. There is no guarantee that the Company’s products will be reimbursed even at tiers where the reimbursement amounts are minimal. In some countries, particularly the countries of the E.U., the pricing of prescription pharmaceuticals is subject to government control. In these countries, pricing negotiations with governmental authorities can take considerable time and delay the introduction of a product to the market. To obtain reimbursement or pricing approval in some countries, the Company may be required to conduct a clinical trial that compares the cost effectiveness of its product candidate to other available therapies. If reimbursement of the Company’s product is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, its business could be adversely affected. In addition, any country could pass legislation or change regulations affecting the pricing of pharmaceuticals before or after a regulatory agency approves any of its product candidates for marketing in ways that could adversely affect the Company. While the Company cannot predict the likelihood of any legislative or regulatory changes, if any government or regulatory agency adopts new legislation or new regulations, the Company’s business could be harmed. Potential Product Liability The Company may be subject to product liability claims associated with the use of its products either after their approval or during clinical trials and there can be no assurance that liability insurance will continue to be available on commercially reasonable terms or at all. Product liability claims might also exceed the amounts or fall outside of such coverage. Product liability claims against the Company, regardless of their merit or potential outcome, could be costly and divert management’s attention from other business matters or adversely affect its reputation and the demand for its products. In addition, certain drug retailers and distributors require minimum liability insurance as a condition of purchasing or accepting products for retail or wholesale distribution. Failure to satisfy such insurance requirements could impede the ability of the Company or its potential partners in achieving broad retail distribution of its products, which could materially adversely impact the Company. There can be no assurance that a product liability claim or series of claims brought against the Company would not materially adversely impact the Company’s business, financial condition, results of operations or cash flows. If any claim is brought against the Company, regardless of the success or failure of the claim, there can be no assurance that the Company will be able to obtain or maintain product liability insurance in the future on acceptable terms or with adequate coverage against potential liabilities or the cost of a recall. Quarterly Fluctuations The Company’s quarterly and annual operating results are likely to fluctuate in the future. These fluctuations could cause the Company’s stock price to decline. The nature of the Company’s business involves variable factors, such as the timing of launch and market acceptance of the Company’s products, the timing and costs associated with the research, development and regulatory submissions of the Company’s products in development, the costs of maintaining manufacturing facilities operating below capacity and the costs associated with public company and other regulatory compliance. As a result, in some future quarters or years, the Company’s clinical, financial or operating results may not meet the expectations of securities analysts and investors which could result in a decline in the price of Nuvo’s stock. Acquisition and Integration of Complementary Technologies or Businesses The Company may pursue product or business acquisitions that could complement or expand its business. However, it may not be able to identify appropriate acquisition candidates in the future. If an acquisition candidate is identified, the Company may not be able to successfully negotiate the terms of any such acquisition or finance such acquisition. Any such acquisition could result in unanticipated costs or liabilities, diversion of management’s attention from the core business, the expenditure of resources and the potential loss of key employees, particularly those of the acquired organizations. In addition, the Company may not be able to successfully integrate any businesses, products, technologies or personnel that it might acquire in the future, which may harm its business. To the extent the Company issues common shares or other rights to finance any acquisition, existing shareholders may be diluted. In connection with an acquisition, the Company may acquire goodwill and other long-lived assets that are subject to impairment tests, which could result in future impairment charges. Inability to Achieve Expected Savings from Restructurings The Company may, from time-to-time, seek to restructure its operations, which may require it to incur restructuring charges and it may not be able to achieve the level of benefits that it expects to realize from any restructuring activities or it may not be able to realize these benefits within the expected time frames. Furthermore, upon the closure of any facilities in connection with restructuring efforts, the Company may not be able to divest such facilities at a fair price or in a timely manner. Changes in the amount, timing and nature of charges related to restructurings and the failure to complete or a substantial delay in completing any restructuring plan could materially adversely impact the Company’s business. Losses Due to Foreign Currency Fluctuations The Company anticipates that the majority of the revenue from commercialization of its product candidates may be in currencies other than Canadian dollars. Fluctuation in the exchange rate of the Canadian dollar relative to these other currencies could result in the Company realizing a lower profit margin on sales of its product candidates than anticipated at the time of entering into such commercial agreements. Adverse movements in exchange rates could materially adversely impact the Company’s financial condition and results of operations. Taxes Significant judgment is required in determining the Company’s provision for income taxes and claims for investment tax credits (ITCs) related to qualifying Scientific Research and Experimental Development (SR&ED) expenditures in Canada. Various internal and external factors may have favourable or unfavourable effects on future provisions for income taxes and the Company’s effective income tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, results of audits by tax authorities, changing interpretations of existing tax laws or regulations, changes in estimates of prior years’ items, future levels of R&D spending and changes in overall levels of income before taxes. Furthermore, new accounting pronouncements or new interpretation of existing accounting pronouncements could materially adversely impact the Company’s effective income tax rate. Prior to the Reorganization, the Company was a multinational corporation with global operations. As such, it is subject to the tax laws and regulations of Canadian federal, provincial and local governments, the U.S. and many international jurisdictions, including transfer pricing laws and regulations between many of these jurisdictions. The Company could be impacted by certain tax treatments for various revenue streams in different tax jurisdictions. The Company was subject to withholding taxes on certain of its revenue streams. The withholding tax rates that were used were based on the interpretation of specific tax acts and related treaties. If a tax authority has a different interpretation from the Company’s, it could potentially impose additional taxes, penalties or fines. This would potentially reduce the amounts of revenue ultimately received by the Company. The Company, from time-to-time, has executed multiple reorganization transactions impacting its tax structure. If a tax authority has a different interpretation from the Company’s, it could potentially impose additional taxes, penalties or fines. Volatility of Share Price Market prices for pharmaceutical related securities, including those of the Company, have been historically volatile and subject to substantial fluctuations. The stock market, from time-to-time, experiences significant price and volume fluctuations unrelated to the operating performance of particular companies. Future announcements concerning the Company or its competitors, including the results of testing, technological innovations, new commercial products, marketing arrangements, government regulations, developments concerning regulatory actions affecting the Company’s products and its competitors’ products in any jurisdiction, developments concerning proprietary rights, litigation, additions or departures of key personnel, cash flow, public concerns about the safety of the Company’s products and economic conditions and political factors in the U.S., E.U., Canada or other regions may have a significant impact on the market price of the common shares. In addition, there can be no assurance that the common shares will continue to be listed on the TSX. The market price of the Company’s common shares could fluctuate significantly for many other reasons, including for reasons unrelated to our specific performance, such as reports by industry analysts, investor perceptions or negative announcements by our customers, competitors or suppliers regarding their own performance, as well as general economic and industry conditions. For example, to the extent that other companies within our industry experience declines in their stock price, the share price of the Company’s common shares may decline as well. In addition, when the market price of a company’s shares drops significantly, shareholders may institute securities class action lawsuits against the company. A lawsuit against the Company could result in substantial costs and could divert the time and attention of the Company’s management and other resources. Ability to Have Access to Additional Financing and Capital and Dilution The Company may consider issuing debt or equity securities in the future to fund potential acquisitions or for general corporate purposes. If the Company raises additional funding or completes an acquisition or merger by issuing additional equity securities, such issuance may substantially dilute the interests of shareholders of the Company and reduce the value of their investment. The market price of the Company’s common shares could decline as a result of issuances of new shares or sales by existing shareholders of common shares in the market or the perception that such sales could occur. Sales by shareholders might also make it more difficult for the Company itself to sell equity securities at a time and price that it deems appropriate. If the Company incurs debt, it may increase its leverage relative to its earnings or to its equity capitalization, requiring the Company to pay interest expenses. The Company may not be able to market such issuances on favourable terms, or at all, in which case, the Company may not be able to execute its business plan. Active Trading Market for Common Shares The Company’s common shares are listed for trading on the TSX and the OTCQX. There can be no assurance that an active trading market in the Company’s common shares on the TSX and the OTCQX will be sustained. Securities Industry Analyst Research Reports The trading market for the Company’s common stock is influenced by the research and reports that industry or securities analysts publish about the Company or any of its partners. If covered, a decision by an analyst to cease coverage of the Company or failure to regularly publish reports on the Company, could cause the Company to lose visibility in the financial markets, which in turn could cause the stock price or trading volume to decline. Moreover, if an analyst who covers the Company or any of its partners downgrades its, or its partner’s stock or if operating results do not meet analysts’ expectations, the stock price could decline. Currently, to the Company’s knowledge, there is one analyst who publishes research reports about the Company. The Company and its products have also been discussed in analyst research reports published about its partners and competitors. Compliance with Laws and Regulations Affecting Public Companies Any future changes to the laws and regulations affecting public companies, compliance with existing provisions of Multilateral Instrument 52-109 – Certification of Disclosure in Issuer’s Annual and Interim Filings of the Canadian Securities Administrators and the other applicable Canadian securities laws and regulation and related rules and policies, may cause the Company to incur increased costs as it evaluates the implications of new rules and implements any new requirements. Delays or a failure to comply with the new laws, rules and regulations could result in enforcement actions, the assessment of other penalties and civil suits. Any new laws and regulations may make it more expensive for the Company to provide indemnities to the Company’s officers and directors and may make it more difficult to obtain certain types of insurance, including liability insurance for directors and officers. Accordingly, the Company may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for the Company to attract and retain qualified persons to serve on its Board of Directors or as executive officers. The Company may be required to hire additional personnel and utilize additional outside legal, accounting and advisory services, all of which could cause general and administrative costs to increase beyond what the Company currently has planned. The Company is continuously evaluating and monitoring developments with respect to these laws, rules and regulations and it cannot predict or estimate the amount of the additional costs it may incur or the timing of such costs. The Company is required annually to review and report on the effectiveness of its internal control over financial reporting in accordance with Multilateral Instrument 52-109 – Certification of Disclosure in Issuer’s Annual and Interim Filings of the Canadian Securities Administrators. The results of this review are reported in the Company’s Annual Report and in its Management’s Discussion and Analysis of Results of Operations and Financial Condition. The Company’s Chief Executive Officer and Chief Financial Officer are required to report on the effectiveness of the Company’s internal control over financial reporting. Management’s review is designed to provide reasonable assurance, not absolute assurance, that all material weaknesses existing within the Company’s internal controls are identified. Material weaknesses represent deficiencies existing in the Company’s internal controls that may not prevent or detect a misstatement occurring which could have a material adverse effect on the quarterly or annual financial statements of the Company. In addition, management cannot provide assurance that the remedial actions being taken by the Company to address any material weaknesses identified will be successful, nor can management provide assurance that no further material weaknesses will be identified within its internal controls over financial reporting in future years. If the Company fails to maintain effective internal controls over its financial reporting, there is the possibility of errors or omissions occurring or misrepresentations in the Company’s disclosures which could materially adversely impact the Company’s business, its financial statements and the value of the Company’s common shares. Additional Risks Additional risks that could materially adversely affect the Company’s business or an investment in the common shares include, but are not limited to: • • • • • • • • • • • • • • Ability to protect know how and trade secrets Rapid technological change could make products or drug delivery technology obsolete Prolonged development time Hazardous materials and environmental Security and Cyber Security Breaches Accumulated deficit Personnel Information technology infrastructure Litigation and regulation Issue of preferred shares Absence of dividends Shareholders’ rights plan Public company requirements may strain resources Management of growth Additional Information Additional information relating to the Company, including the Company’s most recently filed AIF and Nuvo Reorganization Circular, can be found on SEDAR at www.sedar.com. Management’s Report The accompanying Consolidated Financial Statements have been prepared by management and approved by the Board of Directors of the Company. Management is responsible for the information and representations contained in these financial statements and the accompanying Management’s Discussion and Analysis. The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). The significant accounting policies followed by the Company are set out in Note 3 to these Consolidated Financial Statements. To assist management in discharging these responsibilities, the Company maintains a system of procedures and internal controls which are designed to provide reasonable assurance that its assets are safeguarded, that transactions are executed in accordance with management’s authorization, and that the financial records form a reliable base for the preparation of accurate and timely financial information. The Company’s external auditors are appointed by the shareholders. They independently perform the necessary tests of accounting records and procedures to enable them to report their opinion as to the fairness of the consolidated financial statements and their conformity with IFRS. The Board of Directors ensures that management fulfills its responsibilities for financial reporting and internal control. The Board of Directors exercises this responsibility through an Audit Committee composed of three Directors, all of whom are not involved in the day-to-day operations of the Company. The Audit Committee meets quarterly with management, and with external auditors to review audit recommendations and any matters that the auditors believe should be brought to the attention of the Board of Directors. The Audit Committee reviews the Consolidated Financial Statements and Management’s Discussion and Analysis and recommends their approval to the Board of Directors. /s/ Jesse F. Ledger /s/ N. Nicole Rusaw Jesse F. Ledger President & Chief Executive Officer March 22, 2018 N. Nicole Rusaw Interim Chief Financial Officer March 22, 2018 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) To the Shareholders of Nuvo Pharmaceuticals Inc. INDEPENDENT AUDITORS’ REPORT We have audited the accompanying consolidated financial statements of Nuvo Pharmaceuticals Inc. (the “Company”), which comprise the consolidated statements of financial position as at December 31, 2017 and 2016 and the consolidated statements of income and comprehensive income, changes in equity and cash flows for the years ended December 31, 2017 and 2016, and a summary of significant accounting policies and other explanatory information. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Nuvo Pharmaceuticals Inc. as at December 31, 2017 and 2016, and their financial performance and cash flows for the years ended December 31, 2017 and 2016 in accordance with International Financial Reporting Standards. March 22, 2018 Toronto, Canada Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) NUVO PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (Canadian dollars in thousands) Notes $ $ As at December 31, 2017 As at December 31, 2016 ASSETS CURRENT Cash and cash equivalents Short-term investments Accounts receivable Inventories Other current assets TOTAL CURRENT ASSETS NON-CURRENT Property, plant and equipment Intangible assets Goodwill TOTAL ASSETS LIABILITIES AND EQUITY CURRENT Accounts payable and accrued liabilities Current portion of other obligations TOTAL CURRENT LIABILITIES Other obligations TOTAL LIABILITIES EQUITY Common shares Contributed surplus Accumulated other comprehensive income (loss) (AOCI) Deficit TOTAL EQUITY TOTAL LIABILITIES AND EQUITY Commitments (Note 16) See accompanying Notes. On behalf of the Nuvo Board of Directors: 17 17 17 5 6 7 4, 8 4 10, 20 4 4 9 9, 10 8,398 2,000 1,875 2,502 437 9,589 8,000 2,386 3,817 1,500 15,212 25,292 4,283 9,236 1,187 29,918 3,134 332 3,466 1,301 4,767 185,266 14,763 (1) 1,224 - - 26,516 3,646 2 3,648 7 3,655 185,255 14,062 2 9 (174,877) (176,458) 25,151 29,918 22,861 26,516 /s/ Anthony E. Dobranowski /s/ Robert Harris Anthony E. Dobranowski Director Robert Harris Director Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) NUVO PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Year ended December 31, 2017 Year ended December 31, 2016 (Canadian dollars in thousands, except per share and share figures) Notes $ REVENUE Product sales Royalties Contract revenue Total revenue OPERATING EXPENSES Cost of goods sold Research and development expenses General and administrative expenses Net interest income Total operating expenses OTHER EXPENSES (INCOME) Foreign currency loss Other income 19 19 19 16,338 816 369 17,523 5, 10, 12 10, 12 10, 12, 20 8,115 571 7,120 (157) 15,649 Gain on asset disposal Net income before income taxes from continuing operations Income tax expense NET INCOME FROM CONTINUING OPERATIONS NET LOSS FROM DISCONTINUED OPERATIONS NET INCOME Other comprehensive income (loss) to be reclassified to net income in subsequent periods Unrealized gain (loss) on translation of foreign operations TOTAL COMPREHENSIVE INCOME Net income from continuing operations per common share - basic - diluted Net loss from discontinued operations per common share - basic and diluted Net income per common share - basic - diluted Average number of common shares outstanding (in thousands) - basic - diluted See accompanying Notes. 14 15 11 11 11 11 11 336 (44) - 1,582 1 1,581 - 1,581 (3) 1,578 0.14 0.12 - 0.14 0.12 11,550 11,723 $ 24,824 1,023 1,192 27,039 11,357 1,417 6,677 (144) 19,307 348 - (25) 7,409 - 7,409 (3,180) 4,229 50 4,279 0.65 0.63 (0.28) 0.37 0.36 11,455 11,711 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) NUVO PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Canadian dollars in thousands, except for number of shares) Notes Balance, December 31, 2015 Warrants exercised Stock option compensation expense Unrealized gain on translation of foreign operations Common shares issued under DSU Plan Common shares cancelled on execution Common Shares (000s) 9,10 11,145 54 - $ 9,10 234,763 177 - - 288 - 1,599 of the Arrangement (11,487) (236,539) New common shares issued on execution of the Arrangement Unrealized income on translation of foreign operations transferred to Crescita Therapeutics Inc. (Crescita) Distribution of Crescita Stock options exercised Employee contributions to Share Purchase Plan Employer’s portion of Share Purchase Plan Net income Balance, December 31, 2016 Stock option compensation expense Unrealized loss on translation of foreign operations Stock options exercised Net income Balance, December 31, 2017 See accompanying Notes. 11,487 184,926 - - 53 3 - - 293 18 3 - 11,546 - - 5 - 11,551 18 - 185,255 - - 11 - 185,266 Contributed Surplus AOCI Deficit Total $ 9,10 13,956 (19) 231 $ 9 1,059 - - - - - - 50 - - - $ $ (200,059) - - - - - - 49,719 158 231 50 1,599 (236,539) 184,926 - - (106) (1,107) - - - 19,372 - (1,107) 19,372 187 - 18 - - - 14,062 705 - (4) - 14,763 - - - 2 - - 4,229 (176,458) - (3) - - (1) - - 1,581 (174,877) 18 4,229 22,861 705 (3) 7 1,581 25,151 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) NUVO PHARMACEUTICALS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31, 2017 Year ended December 31, 2016 Notes 15 7, 12 10 5 13 7 8 4 1 9 9 10 (Canadian dollars in thousands) OPERATING ACTIVITIES Net income from continuing operations Net loss from discontinued operations Items not involving current cash flows: Depreciation and amortization Equity-settled stock-based compensation Unrealized foreign exchange loss Inventory write-down Interest and accretion of long-term other obligations Other Net change in non-cash working capital CASH PROVIDED BY OPERATING ACTIVITIES INVESTING ACTIVITIES Disposal (acquisition) of short-term investments Acquisition of property, plant and equipment Development of intangible assets Resultz acquisition CASH USED IN INVESTING ACTIVITIES FINANCING ACTIVITIES Cash transferred to Crescita Issuance of common shares Exercise of warrants Repayment of capital lease and other obligations Exercise of stock options CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES Effect of exchange rate changes on cash Net change in cash during the year Cash, beginning of year CASH AND CASH EQUIVALENTS, END OF YEAR See accompanying Notes. Supplemental Cash Flow Information: Interest received1 Income taxes paid1 $ 1,581 - 258 705 274 15 - - 2,833 1,658 4,491 6,000 (2,606) (16) (8,781) (5,403) - - - (2) 7 5 (284) (1,191) 9,589 8,398 155 1 $ 7,409 (3,180) 233 1,848 41 - 7 3 6,361 (2,493) 3,868 (8,000) (368) - - (8,368) (35,016) 205 158 (55) - (34,708) 117 (39,091) 48,680 9,589 65 - 1. Amounts received for interest and paid for income taxes were reflected as operating cash flows in the Consolidated Statements of Cash Flows. Total Cash and Short-term Investments Cash and cash equivalents Short-term investments December 31, 2017 December 31, 2016 $ 8,398 2,000 10,398 $ 9,589 8,000 17,589 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) NUVO PHARMACEUTICALS™ INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (audited) Unless noted otherwise, all amounts shown are in thousands of Canadian dollars, except per share amounts. 1. NATURE OF BUSINESS Nuvo Pharmaceuticals Inc. (Nuvo or the Company) is a commercial healthcare company with a portfolio of products and pharmaceutical manufacturing capabilities. Nuvo has four commercial products that are available in a number of countries: Pennsaid® 2%, Pennsaid, Resultz® and the heated lidocaine/tetracaine patch (HLT Patch). The Company’s registered office and principal place of business is located at 6733 Mississauga Road, Suite 610, Mississauga, Ontario, L5N 6J5. Pennsaid 2% Pennsaid 2% is the follow-on product to original Pennsaid (described below). Pennsaid 2% is a topical pain product that combines a dimethyl sulfoxide (DMSO) based transdermal carrier with 2% diclofenac sodium, a leading NSAID, compared to 1.5% for original Pennsaid. Pennsaid 2% is more viscous than original Pennsaid, is supplied in a metered dose pump bottle and has been approved in the United States for twice-daily dosing compared to four times a day for Pennsaid. On January 16, 2014, Pennsaid 2% was approved in the U.S. for the treatment of the pain of osteoarthritis (OA) of the knee. The sales and marketing rights in the U.S. were originally licensed to Mallinckrodt Inc. (Mallinckrodt). In September 2014, the Company reached a settlement related to its litigation with Mallinckrodt. Under the terms of the settlement agreement, Mallinckrodt paid US$10.0 million to settle the claims and returned the sales and marketing rights for Pennsaid 2% and Pennsaid to Nuvo. In October 2014, the Company sold the U.S. rights to Pennsaid 2% to Horizon Pharma plc (Horizon) for US$45.0 million. In January 2015, Horizon launched its commercial sale and marketing of Pennsaid 2% in the U.S. Pennsaid 2% is currently manufactured by the Company for sale to Horizon. Pennsaid Pennsaid is a combination of a DMSO-based transdermal carrier and 1.5% diclofenac sodium and delivers the active drug through the skin at the site of pain. It is used to treat the signs and symptoms of OA of the knee. It is approved for sale and marketing in several countries, including Canada, where it is licensed to Paladin Labs Inc. As a result of the litigation settlement with Mallinckrodt, the U.S. sales and marketing rights to Pennsaid were returned to the Company. Under the terms of the agreement with Horizon for the sale of the Pennsaid 2% rights, the Company agreed to discontinue the manufacture, sale and marketing of Pennsaid in the U.S. HLT Patch The HLT Patch is a topical patch that combines lidocaine, tetracaine and heat, using Nuvo’s proprietary Controlled Heat-Assisted Drug Delivery (CHADD™) technology. The HLT Patch is approved in the U.S. to provide local dermal analgesia for superficial venous access and superficial dermatological procedures and is marketed by Galen US Incorporated (Galen) under the brand name Synera. In Europe, the HLT Patch is approved for surface anaesthesia of normal intact skin and is marketed by the Company’s European-based licensee, Eurocept International B.V. (Eurocept) under the brand name Rapydan. Resultz Acquisition In December 2017, the Company acquired the global, ex-U.S. product and intellectual property rights to Resultz from Piedmont Pharmaceuticals LLC (Piedmont). The transaction included existing royalty streams in France, Spain, Portugal, Belgium, Ireland and the United Kingdom, Canada, Russia, Australia and Israel (collectively the Royalty Markets), generated from a network of existing global licensees and license agreements that were assumed by Nuvo. Under the terms of the agreement, Nuvo paid US$7.0 million ($8.8 million) on close to Piedmont. The transaction also included a single-digit royalty payable by Nuvo on net sales generated from non-Royalty Markets through 2023 and potential added future consideration in the form of payments for achieving certain aggregate annual net sales-based milestones (See Note 4, Acquisition of Resultz Product and Intellectual Property Rights). In January 2018, the Company’s wholly owned subsidiary, Nuvo Pharmaceuticals (Ireland) Limited (Nuvo Ireland) acquired the U.S. rights to Resultz from Piedmont. Resultz was cleared as a Class 1 medical device by the U.S. Food and Drug Administration (FDA) in May 2017 and has not yet been commercially launched in the U.S. (See Note 22, Subsequent Event - Resultz U.S. Asset Purchase). Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Resultz is a commercial-stage, over-the-counter (OTC) product intended to kill head lice and remove their eggs from hair with as little as a 5-minute treatment. It is a pesticide-free, topical solution that contains only two common cosmetic ingredients - 50% isopropyl myristate and 50% cyclomethicone D5. It is clinically proven to achieve 100% effectiveness when used as directed. Nuvo Reorganization On March 1, 2016, Nuvo completed a transaction (the Reorganization) pursuant to which Nuvo was reorganized into two separate publicly traded companies, Nuvo and Crescita Therapeutics Inc. (Crescita). The Reorganization proceeded by way of arrangement under the Canada Business Corporations Act (the Arrangement). Per the terms of the Arrangement, Nuvo transferred $35.0 million to Crescita and changed its name from “Nuvo Research Inc.” to “Nuvo Pharmaceuticals Inc.” Detailed information regarding the Reorganization and its effects, including a description of certain risks and uncertainties in respect of the Reorganization and the operations of the Company and Crescita as separate publicly traded companies, is included in the Management Information Circular dated December 31, 2015 (Nuvo Reorganization Circular) that is available under the Company’s profile at www.sedar.com. Prior to the Reorganization, Nuvo operated two distinct business units: Nuvo and Crescita. Nuvo is a commercial healthcare company with a portfolio of commercial products and pharmaceutical manufacturing capabilities. Prior to the Reorganization, Crescita was a drug development business. The operations related to Crescita are accounted for as a discontinued operation (See Note 15, Discontinued Operations). 2. BASIS OF PREPARATION Statement of Compliance These Consolidated Financial Statements have been prepared by management in accordance with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB). The policies applied to these Consolidated Financial Statements are based on IFRS, which have been applied consistently to all periods presented. These Consolidated Financial Statements were issued and effective as at March 22, 2018, the date the Board of Directors approved these Consolidated Financial Statements. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Measurement These Consolidated Financial Statements have been prepared under the historical cost convention, except for the revaluation of certain financial assets and financial liabilities to fair value. Items included in the financial statements of each consolidated entity in the Company are measured using the currency of the primary economic environment in which the entity operates (the functional currency). These Consolidated Financial Statements are presented in Canadian dollars, which is the Company’s functional currency. Use of Estimates and Judgments The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of these Consolidated Financial Statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates and such differences could be material. Key areas of estimation or use of managerial assumptions are as follows: (i) Purchase Price Allocation, Intangible Assets and Goodwill: The purchase price allocation process resulting from a business combination requires management to estimate the fair value of identifiable assets acquired including intangible assets and liabilities assumed including any contingent and variable consideration. The Company uses valuation techniques to determine fair values, which are generally based on forecasted future net cash flows discounted to present value. These valuations are closely linked to the assumptions used by management on the future performance of the related assets and the discount rates applied. See Note 4, Acquisition of Resultz Product and Intellectual Property Rights for the assumptions used by management and the discount rates applied. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) The Company’s accounting policy relating to transactions or other events considered to be a business combination is described in Note 3, Summary of Significant Accounting Policies - Business Combinations. In applying this policy, judgment is used when determining whether such transactions should be treated as an asset acquisition or a business combination. During the year ended December 31, 2017, management concluded that the acquisition of the ex-U.S. product and intellectual property rights to Resultz was a business combination in the scope of IFRS 3, Business Combinations, as the acquired assets met the definition of a business. (ii) Discontinued Operations: The Company’s discontinued operations reflect Crescita on a combined carve-out basis as if it had always operated as a stand-alone entity. Prior to March 1, 2016, Nuvo paid certain costs for Crescita and performed certain activities on behalf of Crescita. As a result, the Company’s discontinued operations include allocations of certain transactions reported in the accounts of Nuvo. These cost allocations have been determined on a basis considered by the Company to be a reasonable reflection of the utilization of services provided to Crescita. Compensation-related costs have been allocated using methodologies primarily based on proportionate time spent on Nuvo and Crescita’s respective activities. Management believes both the assumptions and allocations underlying the discontinued operations are reasonable. However, as a result of the combined carve-out methodology in determining the results of Crescita, the discontinued operations may not necessarily be indicative of the operating results and financial position that would have resulted had Crescita historically operated as a stand-alone entity. (iii) Share-based Payments: The Company measures the cost of share-based payments, either equity or cash-settled with employees by reference to the fair value of the equity instrument or underlying equity instrument at the date on which they are granted. In addition, cash-settled, share-based payments are revalued to fair value at every reporting date. Estimating fair value for share-based payments requires management to determine the most appropriate valuation model for a grant, which is dependent on the terms and conditions of each grant. In valuing certain types of stock- based payments, such as incentive stock options and stock appreciation rights, the Company uses the Black- Scholes option pricing model. Several assumptions are used in the underlying calculation of fair values of the Company’s stock options and stock- appreciation rights using the Black-Scholes option pricing model, including the expected life of the option, stock- price volatility and forfeiture rates. (iv) Revenue Recognition: As is typical in the pharmaceutical industry, the Company’s royalty streams are subject to a variety of deductions that are generally estimates and recorded in the same period that the revenues are recognized and primarily represent rebates, discounts, incentives and product returns. These deductions represent estimates of the related obligations. Amounts recorded for sales deductions can result from a complex series of judgments about future events and uncertainties and can rely on estimates and assumptions. (v) Impairment of Non-financial Assets: The Company reviews the carrying value of non-financial assets for potential impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. However, goodwill and indefinite life intangible assets are tested for impairment annually at December 31st. The impairment test on cash-generating units (CGUs) is carried out by comparing the carrying amount of the CGU and its recoverable amount. The recoverable amount of a CGU is the higher of fair value, less costs to sell, and its value in use. This complex valuation process entails the use of methods, such as the discounted cash flow method, which requires numerous assumptions to estimate future cash flows. The recoverable amount is impacted significantly by the discount rate selected to be used in the discounted cash flow model, as well as the quantum and timing of expected future cash flows and the growth rate used for the extrapolation. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Basis of Consolidation These Consolidated Financial Statements include the accounts of the Company and its subsidiaries as follows: Dimethaid (UK) Ltd. Nuvo Pharmaceuticals (Ireland) Limited % Ownership 100% 100% The Company controls its subsidiaries with the power to govern its financial and operating policies. All significant intercompany balances and transactions have been eliminated upon consolidation. Business Combinations The Company applies the acquisition method in accounting for business combinations. The consideration transferred by the Company is calculated as the total of the acquisition-date fair values of assets transferred and liabilities incurred by the Company to gain control of the acquiree, which includes the fair value of any asset or liability arising from a contingent consideration arrangement. Acquisition costs are expensed as incurred and included in general and administrative (G&A) expenses. Assets acquired and liabilities assumed are measured at their acquisition-date fair values. Foreign Currency Translation The Company and its subsidiary companies each determine their functional currency based on the currency of the primary economic environment in which they operate. The Company’s functional currency is the Canadian dollar and its subsidiary companies’ functional currencies are either the British pound or the euro. (i) Transactions Transactions denominated in a currency other than the functional currency of an entity are translated at exchange rates prevailing at the time the transaction occurred. The resulting exchange gains and losses are included in each entity’s net income (loss) in the period in which they arise. (ii) Translation into Presentation Currency The Company’s foreign operations are translated into the Company’s presentation currency, which is the Canadian dollar, for inclusion in these Consolidated Financial Statements. Foreign-denominated monetary and non-monetary assets and liabilities of foreign operations are translated at exchange rates in effect at the end of the reporting period, and revenue and expenses are translated at the average exchange rate for the period (as this is considered a reasonable approximation to actual rates). The resulting translation gains and losses are included in other comprehensive income (loss) (OCI) with the cumulative gain or loss reported in accumulated other comprehensive income (loss) (AOCI). When the Company disposes of its entire interest in a foreign operation or loses control or influence over a foreign operation, the foreign currency gains or losses in AOCI related to the foreign operation are recognized in profit or loss. If the Company disposes of part of an interest in a foreign operation that remains a subsidiary, the proportionate amount of foreign currency gains or losses in AOCI related to the subsidiary are reallocated between controlling and non-controlling interests. Cash and cash equivalents Cash includes cash on hand and current balances with banks and cash equivalents include money market mutual funds. These are readily convertible into known amounts of cash and have an insignificant risk of changes in value. Cost approximates fair value. Short-term Investments Short-term investments are held in highly liquid instruments such as guaranteed investment certificates, with an original term to maturity of more than three months and expected to be realized in less than one year. Inventories Inventories include raw materials, work-in-process and finished goods. Raw materials are stated at the lower of cost and replacement cost with cost determined on a first-in, first-out basis. Manufactured inventory (finished goods Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) and work-in-process) is valued at the lower of cost and net realizable value determined on a first-in, first-out basis. Manufactured inventory cost includes the cost of raw materials, direct labour, an allocation of overhead and the cost to acquire finished goods. The Company monitors the shelf life and expiry of finished goods to determine when inventory values are not recoverable and a write-down is necessary. Property, Plant and Equipment Property, plant and equipment (PP&E) is recorded at cost. Assets acquired under finance leases are carried at cost, which is the present value of minimum lease payments after deduction of any executory costs. The Company allocates the amount initially recognized in respect of an item of PP&E to its significant parts and amortizes separately each such part. Depreciation of PP&E is provided for over the estimated useful lives from the date the assets become available for use as follows: Buildings Leasehold improvements Furniture and fixtures Computer equipment and software Production, laboratory and other equipment 10 - 25 years Term of lease 5 years 1 - 3 years 3 - 12 years Straight-line Straight-line Straight-line Straight-line Straight-line Residual values, method of depreciation and useful lives of the assets are reviewed annually and adjusted if appropriate. Intangible Assets Intangible assets acquired in a business combination are recognized separately from goodwill at their fair value at the date of acquisition, which is considered to be cost. Following initial recognition, intangible assets are carried at cost, less any accumulated amortization and accumulated impairment losses. Amortization commences when the intangible asset is available for use and for patented assets is computed on a straight-line basis over the intangible asset’s estimated useful life, which cannot exceed the lesser of the remaining patent life and 20 years. The estimated useful lives are as follows: Brand Patents Indefinite life 5 - 20 years - Straight-line Goodwill Goodwill represents the future economic benefits arising from a business combination that are not individually identified and separately recognized. Goodwill is initially measured at cost, as the excess of the aggregate of the consideration transferred over the net identifiable assets acquired and liabilities assumed. After initial recognition, Goodwill is carried at cost less accumulated impairment losses. See Note 3, Summary of Significant Accounting Policies - Impairment of Non-financial Assets for a description of impairment testing procedures. Impairment of Non-financial Assets The Company reviews the carrying value of non-financial assets for potential impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. CGUs to which goodwill and indefinite life intangible assets have been allocated are tested for impairment at least annually. For the purpose of measuring recoverable amounts, assets are grouped at the lowest levels for which there are separately identifiable cash flows or CGUs. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use (being the present value of the expected future cash flows of the relevant asset or CGU). An impairment loss is recognized for the amount by which the asset’s carrying value exceeds its recoverable amount. Goodwill is allocated to the CGU that is expected to benefit from synergies of a related business combination and represent the lowest level within the Company at which management monitors goodwill. The Company has recognized goodwill from the Resultz acquisition as disclosed in Note 4, Acquisition of Resultz Product and Intellectual Property Rights. Goodwill associated with the acquisition is generated from the expected net cash inflows for the ex-U.S. Resultz product, which management considers to be the CGU for purposes of testing impairment. For non-financial assets other than goodwill, a previously recognized impairment loss is reversed only if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized. If this is the case, the carrying amount of the asset is increased to its recoverable amount, but Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) cannot exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset in prior years. An impairment reversal is recognized as other income. Leases Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the Company. All other leases are classified as operating leases. The capitalized finance lease obligation reflects the present value of future lease payments, discounted at the appropriate interest rate. Assets under finance leases are amortized over the term of the lease. All other leases are accounted for as operating leases with rental payments being expensed on a straight-line basis. Financial Instruments All financial instruments are classified into one of the following five categories: fair value through profit or loss (FVTPL), held-to-maturity investments, loans and receivables, available-for-sale assets or other financial liabilities. All financial instruments, including derivatives, are included on the Consolidated Statements of Financial Position and are measured at fair market value upon inception. Subsequent measurement and recognition of changes in the fair value of financial instruments depend on their initial classification. FVTPL financial investments are measured at fair value, and all gains and losses are included in operations in the period in which they arise. Available-for-sale financial instruments are measured at fair value with revaluation gains and losses included in OCI until the asset is removed from the Consolidated Statements of Financial Position. Loans and receivables, instruments held-to-maturity and other financial liabilities are measured at amortized cost using the effective interest method. Gains and losses upon inception, impairment write-downs and foreign exchange translation adjustments are recognized immediately. The Company classifies its financial instruments as follows: • Cash, cash equivalents and accounts receivable are classified as loans and receivables and are measured at amortized cost. Interest income is recorded in net income (loss), as applicable. • Short-term investments are classified as held for trading and are measured at FVTPL. • Accounts payable and accrued liabilities are classified as other financial liabilities and are measured at amortized cost using the effective interest method. Interest expense is recorded in net income (loss), as applicable. Impairment of Financial Assets As at each reporting date, the Company assesses whether there is objective evidence that a financial asset is impaired. If such evidence exists, the Company recognizes an impairment loss. For financial assets carried at amortized cost, the loss is the difference between the amortized cost of the loan or receivable and the present value of the estimated future cash flows, discounted using the instrument’s original effective interest rate. The carrying value of the asset is reduced by this amount either directly or indirectly through the use of an allowance account. Comprehensive Income Comprehensive income is the change in equity from transactions and other events and circumstances from non- shareholder sources. Other comprehensive income refers to items recognized in comprehensive income, but that are excluded from net income calculated in accordance with IFRS. The resulting changes from translating the financial statements of foreign operations into the Company’s presentation currency of Canadian dollars are recognized in comprehensive income for the year. Revenue Recognition The Company recognizes revenue from product sales, royalties, contract service and licensing arrangements, which may include multiple elements. Revenue arrangements with multiple elements are reviewed, in order to determine whether the multiple elements can be divided into separate units of accounting, if certain criteria are met. If separable, the consideration received is allocated amongst the separate units of accounting based on their respective fair values, and the applicable revenue recognition criteria is applied to each of the separate units. If not separable, the applicable revenue recognition criteria are applied to combined elements as a single unit of accounting. Product Sales Revenue from product sales is recognized upon shipment of the product to the customer, provided transfer of title to the customer occurs upon shipment and provided the Company has not retained any significant risks of ownership or future obligations with respect to the product shipped, the price is fixed and determinable and Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) collection is reasonably assured. Where applicable, revenue from product sales is recognized net of reserves for estimated sales discounts and allowances, returns, rebates and chargebacks. Royalties Revenue arising from royalties is recognized when reasonable assurance exists regarding measurement and collectability. Royalties are typically calculated as a percentage of net sales realized by the Company’s licensees of its products (including their sublicensees), as specifically defined in each agreement. The licensees’ sales generally consist of revenue from product sales of the Company’s pharmaceutical products and net sales are determined by deducting the following: estimates for chargebacks, rebates, sales incentives and allowances, returns and losses and other customary deductions in each region where the Company has licensees. The Company only recognizes as revenue when reasonable assurance exists regarding measurement and collectability. Royalty revenue from the launch of a product in a new territory, for which the Company or its licensee are unable to develop the requisite historical data on which to base estimates of returns, may be deferred until such time that a reasonable estimate can be made and once the product has achieved market acceptance. Licensing Arrangements The Company may enter into licensing agreements for supply and distribution for its commercial products. The terms of the agreements may include non-refundable signing and licensing fees, milestone payments and royalties on any product sales derived from collaborations. These multiple-element arrangements are analyzed to determine whether the deliverables can be separated or whether they must be accounted for as a single unit of accounting. License fees are recognized as revenue when persuasive evidence of an arrangement exists, the fee is fixed or determinable, delivery or performance has been substantially completed and collection is reasonably assured. If there are no substantive performance obligations over the life of the contract, the upfront non-refundable payment is recognized when the underlying performance obligation is satisfied. If substantive contractual obligations are satisfied over time or over the life of the contract, revenue may be deferred and recognized over the performance. The term over which upfront fees are recognized is revised if the period over which the Company maintains substantive contractual obligations changes. Milestone payments are immediately recognized as licensing revenue when the condition is met, if the milestone is not a condition to future deliverables and collectability is reasonably assured. Otherwise, they are recognized over the remaining term of the agreement or the performance period. Contract Revenue Revenues from contracted services are generally recognized as the contracted services are performed and the related expenditures are incurred pursuant to the terms of the agreement and provided collectability is reasonably assured. Research and Development Research costs, other than capital expenditures, are charged to operations as incurred. Expenditures on internally developed products are capitalized, if it can be demonstrated that: it is technically feasible to develop the product for it to be sold; • • adequate resources are available to complete the development; • • • • expenditure on the project can be measured reliably. there is an intention to complete and sell the product; the Company is able to sell the product; sale of the product will generate future economic benefits; and Development expenses are charged to operations as incurred unless such costs meet the criteria for deferral and amortization. Government Assistance Government assistance received under incentive programs is accounted for using the cost reduction method; whereby, the assistance is netted against the related expense or capital expenditure to which it relates when there is reasonable assurance that the credits will be realized. Government assistance received under reimbursement or funding programs is accounted for using the cost reduction method; whereby, a receivable is set up as the costs are incurred based on the terms of reimbursement or funding program and the expected recoveries are netted against the related expense. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Net Income or Loss Per Common Share Basic net income or loss per common share is calculated using the weighted average number of common shares outstanding during the year. Diluted net income or loss per common share is calculated assuming the weighted average number of common shares outstanding during the year is increased to include the number of additional common shares that would have been outstanding if the dilutive potential shares had been issued. The dilutive effect of warrants, stock options and performance share units is determined using the treasury-stock method. The treasury-stock method assumes that the proceeds from the exercise of warrants and options are used to purchase common shares at the volume weighted average market price during the year. The dilutive effect of convertible securities is determined using the “if-converted” method. The “if-converted” method assumes that the convertible securities are converted into common shares at the beginning of the period and all income charges related to the convertible securities are added back to income. Income Taxes Income taxes on profit or loss include current and deferred taxes. Income taxes are recognized in profit or loss except to the extent that they relate to business combinations or items recognized directly in equity or in OCI. Current taxes are the expected income taxes payable or recoverable on the taxable income or loss for the period, using tax rates enacted or substantively enacted, at the reporting date and any adjustment to income taxes payable in respect of previous years. The Company is subject to withholding taxes on certain forms of income earned under its in-licensing agreements from foreign jurisdictions. Deferred income taxes are generally recognized in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred income taxes are measured at the tax rates that are expected to be applied to temporary differences when they are reversed, based on the tax laws that have been enacted or substantively enacted in the relevant jurisdiction by the reporting date. Deferred tax assets and liabilities are recognized, where the carrying amount of an asset or a liability in the Consolidated Statements of Financial Position differs from its tax base, except for differences arising on: • • • the initial recognition of goodwill; the initial recognition of an asset or a liability in a transaction that is not a business combination and at the time of the transaction affects neither accounting or taxable profit; and investments in subsidiaries, branches and associates, and interests in joint ventures where the Company is able to control the timing of the reversal of the difference and it is probable that the difference will not reverse in the foreseeable future. A deferred tax asset is recognized for unused tax losses, tax credits and deductible temporary differences to the extent it is probable that future taxable income will be available against which they can be utilized. Deferred tax assets are reviewed as at each reporting date and are reduced to the extent it is no longer probable the related tax benefit will be realized. Within the scope of IAS 12, Income Taxes, the Company recognizes its investment tax credits as a reduction against current income tax expense. Stock-based Compensation and Other Stock-based Payments The Company has four stock-based compensation plans: the Share Option Plan, the Share Purchase Plan and the Share Bonus Plan, each a component of the Company’s Share Incentive Plan and the Share Appreciation Rights (SARs) Plan. As part of the Arrangement, the Deferred Share Unit (DSU) Plan for non-employee directors and the DSU Plan for employees was terminated and settled in shares on March 1, 2016. See Note 10, Stock-based Compensation and Other Stock-based Payments. Share Incentive Plan The Company measures and recognizes compensation expense for the Share Incentive Plan based on the fair value of the common shares or options issued. Under the Share Option Plan, the Company issues either fixed awards or performance-based options. Options vest either immediately upon grant or over a period of one to four years or upon the achievement of certain performance-related measures or milestones. Each tranche in an award is considered a separate award with its own vesting period and grant date fair value. Fair value of each tranche is measured at the date of grant using the Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Black-Scholes option pricing model. Compensation expense is recognized over the tranche’s vesting period based on the number of awards expected to vest, by increasing contributed surplus. When options are exercised, the proceeds received by the Company, together with the fair value amount in contributed surplus, are credited to common shares. Under the Share Purchase Plan, consideration paid by employees on the purchase of common shares is credited to common shares when the shares are issued. The fair value of the Company’s matching contribution, determined based upon the trading price of the common shares, is recorded as compensation expense. These expenses are included in stock-based compensation expense and credited to common shares. Under the Share Bonus Plan, the fair value of the direct award of common shares, determined based upon the trading price of the common shares, is recorded as compensation expense. These expenses are included in stock- based compensation expense and credited to contributed surplus over the vesting period, until the common shares are issued and the value is transferred from contributed surplus to common shares. Deferred Share Unit Plan The DSU Plan consisted of two plans: one for non-employee directors and one for employees. Under the DSU Plan, non-employee directors could allot and elect to receive a portion of their annual retainers, and other Board- related compensation, in the form of DSUs and employees could elect to have a portion of their quarterly earnings issued in units of the DSU Plan. One DSU had a cash value equal to the market price of one of the Company’s common shares. Upon issuance, the fair value of the DSUs was recorded as compensation expense and the DSU accrual was established. As at all subsequent reporting dates, the DSU accrual was adjusted to the market value of the underlying shares and the adjustment was recorded as compensation cost. Share Appreciation Rights Plan SARs are issued to directors, officers, employees or designated affiliates to provide incentive compensation based on the appreciation in value of the Company’s common shares. Under the SARs Plan, participants receive, upon vesting, a cash amount equal to the difference between the SARs’ fair market value and the grant price value, also known as the intrinsic value. Fair market value is determined by the closing price of the Company’s common share on the Toronto Stock Exchange (TSX) on the day preceding the exercise date. SARs vest in tranches prescribed at grant date, and each tranche is considered a separate award with its own vesting period and fair value. Until SARs vest, compensation expense is measured based on the fair value of the SARs at the end of each reporting period, using a Black-Scholes option pricing model. The fair value of the liability is remeasured at the end of each reporting date and adjusted at the settlement date, when the intrinsic value is realized. The SARs accrual is included in accounts payable and accrued liabilities. Issuance Costs of Equity Instruments The Company records issuance costs of equity instruments against the equity instrument that was issued. Accounting Standards Adopted There were no new accounting standards adopted by the Company during 2017. Significant Accounting Policies The policies applied in these Consolidated Financial Statements are based on IFRS issued and outstanding as at December 31, 2017. Accounting Standards Issued But Not Yet Applied Certain new standards, interpretations, amendments and improvements to existing standards were issued by the IASB or IFRS Interpretations Committee that are mandatory for fiscal periods beginning on or after January 1, 2018. The standards impacted that may be applicable to the Company are as follows: IFRS 9 - Financial Instruments In July 2014, the IASB issued IFRS 9 - Financial Instruments (IFRS 9), which will replace IAS 39 - Financial Instruments and all previous versions of IFRS 9. IFRS 9 establishes principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash flows. This new standard is effective for the Company’s interim and annual Consolidated Financial Statements commencing January 1, 2018. The Company has completed its assessment of the standard and does not anticipate significant changes to its current recognition policies. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) IFRS 15 - Revenue from Contracts with Customers In May 2014, the IASB issued IFRS 15 - Revenue from Contracts with Customers (IFRS 15), which covers principles for reporting about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. IFRS 15 is effective for annual periods beginning on or after January 1, 2018. The Company will transition applying the modified retrospective approach - i.e. by recognizing the cumulative effect of initially applying IFRS 15 as an adjustment to the opening balance of equity at January 1, 2018. The Company completed its assessment of all customer contracts in existence as at December 31, 2017, excluding contracts assumed from the Resultz acquisition (See Note 4, Acquisition of Resultz Product and Intellectual Property Rights). Based on this assessment, the Company does not anticipate significant adjustments to the opening balance of equity. Due to the timing of the Resultz acquisition, which closed on December 29, 2017, the Company is currently in the process of assessing the quantitative and qualitative implications of the customer contracts acquired under IFRS 15. IFRS 15 requires an entity to disclose additional quantitative and qualitative information about its contracts with customers; therefore, there will be significant changes to the Company’s financial statement disclosures. The Company will be providing more disaggregated information about revenue and additional disclosures about the Company’s remaining performance obligations as at the reporting date. Amendments to IFRS 2 - Share-based Payments In June 2016, the IASB issued amendments to IFRS 2 - Share-based Payments (IFRS 2), clarifying how to account for certain types of share-based payment transactions. The amendments provide requirements on the accounting for: the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments; share-based payment transactions with a net settlement feature for withholding tax obligations and a modification to the terms and conditions of a share-based payment that changes the classification from cash-settled to equity- settled. The amendments to IFRS 2 are effective prospectively for annual periods beginning on or after January 1, 2018. The Company has completed its assessment of the standard and does not anticipate significant changes to its current recognition policies. IFRS 16 - Leases In January 2016, the IASB issued IFRS 16 - Leases (IFRS 16), its new leases standard that requires lessees to recognize assets and liabilities for most leases on their balance sheets. Lessees applying IFRS 16 will have a single accounting model for all leases, with certain exemptions. Lessor accounting is substantially unchanged. The new standard will be effective on or after January 1, 2019, with limited early application permitted. The Company is in the process of reviewing the standard to determine the impact on the Consolidated Financial Statements. Other accounting standards or amendments to existing accounting standards that have been issued, but have future effective dates, are either not applicable or are not expected to have a significant impact on the Company’s annual Consolidated Financial Statements. 4. ACQUISITION OF RESULTZ PRODUCT AND INTELLECTUAL PROPERTY RIGHTS Global Ex-U.S. Product and Intellectual Property Rights On December 29, 2017, the Company acquired control of the global ex-U.S. product and intellectual property rights to Resultz, a topical solution lice and egg removal kit. The transaction included all existing royalty streams in France, Spain, Portugal, Belgium, Ireland and the United Kingdom, Canada, Russia, Australia, and Israel which are generated from a network of existing global licensees and license agreements that were assumed by Nuvo. The transaction also included rights to Resultz in the ex-U.S. non-partnered markets. The transaction has been accounted for as a business combination in the scope of IFRS 3, Business Combinations, as the acquired assets met the definition of a business. The benefits of the acquisition include expanding the Company’s portfolio of commercial products and Resultz can be produced at Nuvo’s Varennes, Québec manufacturing facility. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) The consideration for the acquisition and preliminary purchase price allocation, in accordance with IFRS 3, Business Combinations, are estimated as follows: Fair value of consideration transferred Amount settled in cash Fair value of contingent and variable consideration Total consideration transferred Recognized amounts of identifiable net assets Patents Brand Total identifiable net assets Goodwill on acquisition Acquisition costs charged to general and administrative expenses $ 8,781 1,626 10,407 8,430 790 9,220 1,187 69 The Company has not yet finalized the purchase price allocation, including goodwill, and therefore, the information disclosed above for identifiable assets acquired, and the fair value of the contingent and variable consideration, is subject to fair valuation changes. Consideration Transferred The acquisition of the global ex-U.S. rights to Resultz was settled in US$7.0 million ($8.8 million) from cash on hand. The purchase agreement included additional contingent consideration related to meeting certain milestones in partnered markets, payable only if those targets are achieved, as well as variable consideration based on annual royalties earned in the non-partnered markets. The additional milestone consideration is expected to be paid in 2019 and 2022, while the royalty consideration will be paid annually from the acquisition date until 2028. The $1.6 million fair value of the contingent and variable consideration initially recognized represents the present value of the Company’s probability-weighted estimate of the cash outflow. The contingent consideration reflects management’s estimate that certain targets will be achieved and the variable consideration is based on managements projected royalty income in non-partnered markets. The discount rates used range from 20% - 30% based on the risk of achieving the forecasted sales in the partnered and non-partnered markets. As at December 31, 2017, there have been no changes in the estimate of the probable cash outflow, due to the close proximity of the transaction to year-end. In the absence of a change in fair value, no accretion expense related to this consideration has been recognized in total comprehensive income for 2017. Acquisition-related costs amounting to $69 are recognized as part of G&A expenses for the year ended December 31, 2017 and are not included as part of consideration transferred. Identifiable Net Assets The identifiable net assets were valued using an income approach and discounted using rates of 22% and 25%. The relief from royalty method was chosen as the most appropriate valuation methodology and was determined by estimating the after-tax royalty fee avoided by the Company through ownership of the patent and brand. Goodwill Goodwill of $1.2 million is primarily related to growth expectations, particularly within the non-partnered markets and expected future profitability from royalty streams in both the partnered and non-partnered markets. Goodwill recognized will be deductible for income tax purposes going forward. Contribution to the Company Results If the transaction had closed on January 1, 2017, revenue of the Company for the year ended December 31, 2017 would have increased by $1.9 million, and net income for the year ended December 31, 2017 would have decreased by $0.9 million. The decrease in net income for the year ended December 31, 2017 would be largely attributable to $1.6 million in amortization expense of the acquired patents and $1.2 million of operational costs, the bulk of which are non-recurring. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 5. INVENTORIES Inventories consist of the following as at: Raw materials Work in process Finished goods December 31, 2017 $ 2,162 24 316 2,502 December 31, 2016 $ 3,026 75 716 3,817 During the year ended December 31, 2017, inventories in the amount of $6.7 million were recognized as cost of goods sold [December 31, 2016 - $9.6 million]. During the year ended December 31, 2017, inventories in the amount of $15 were written down [December 31, 2016 - $nil] and there were no reversals of prior year write-downs during the years ended December 31, 2017 and 2016. 6. OTHER CURRENT ASSETS Other current assets consist of the following as at: Deposits(i) Prepaid expenses Other receivables December 31, 2017 $ 117 234 86 437 December 31, 2016 $ 995 276 229 1,500 (i) As at December 31, 2017, deposits included $nil [December 31, 2016 - $932] for deposits on production equipment. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 7. PROPERTY, PLANT AND EQUIPMENT PP&E consists of: Cost Balance, December 31, 2015 Additions Disposals Transferred to Crescita Balance, December 31, 2016 Additions(ii) Disposals Balance, December 31, 2017 Accumulated depreciation Balance, December 31, 2015 Depreciation expense Disposals Transferred to Crescita Balance, December 31, 2016 Depreciation expense Disposals Balance, December 31, 2017 Net book value as at December 31, 2016 Net book value as at December 31, 2017 Land $ Buildings $ 42 - - - 42 - - 42 - - - - - - - - 42 42 2,334 - - (901) 1,433 58 - 1,491 1,685 68 - (901) 852 65 - 917 581 574 Leasehold Improvements $ 114 - - (114) - 194 - 194 114 - - (114) - 3 - 3 - 191 Furniture & Fixtures $ Computer Equipment & Software $ Production, Laboratory & Other Equipment(i) $ 274 - - (214) 60 72 - 132 272 - - (213) 59 - - 59 1 73 1,065 - - (903) 162 49 - 211 1,015 6 - (861) 160 6 - 166 2 45 Total $ 7,601 368 (79) (3,060) 4,830 3,317 (25) 8,122 6,421 233 (79) (2,969) 3,606 258 (25) 3,839 3,772 368 (79) (928) 3,133 2,944 (25) 6,052 3,335 159 (79) (880) 2,535 184 (25) 2,694 598 1,224 3,358 4,283 (i) Production, laboratory and other equipment as at December 31, 2017, included a cost of $11 [December 31, 2016 - $35] and accumulated depreciation of $5 [December 31, 2016 - $27] for assets under finance leases. (ii) During the year ended December 31, 2017, $711 of total PP&E additions were recorded in accounts payable and accrued liabilities. 8. INTANGIBLE ASSETS Intangible assets consist of the following as at: Cost Balance, December 31, 2016 Acquired in Resultz acquisition (Note 4) Additions Balance, December 31, 2017 Accumulated depreciation Balance, December 31, 2016 Amortization expense Balance, December 31, 2017 Net book value as at December 31, 2016 Net book value as at December 31, 2017 Patents $ - 8,430 - 8,430 - - - - Brand $ - 790 - 790 - - - - Development Costs $ - - 16 16 - - - - Total $ - 9,220 16 9,236 - - - - 8,430 790 16 9,236 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 9. CAPITAL STOCK Authorized • Unlimited first and second preferred shares, non-voting, non-participating, issuable in series, number, designation, rights, privileges, restrictions and conditions are determinable by the Company’s Board of Directors. • Unlimited common shares, voting, without par value. Reorganization In connection with the Reorganization of Nuvo into two separate publicly traded companies and under the terms of the Arrangement (See Note 1, Nature of Business), each Nuvo share certificate existing on March 1, 2016 became a common share of Nuvo and the right to receive a Crescita common share. To determine Nuvo’s share capital amount after the Arrangement, Nuvo’s stated capital immediately prior to the Arrangement was split based on the butterfly proportion, as defined in the Nuvo Reorganization Circular, of the Nuvo and Crescita common shares at the effective date of the Arrangement. The butterfly proportion was determined to be 78.18% for Nuvo and 21.82% for Crescita. The butterfly proportion was based on the volume weighted average prices (VWAP) of the Crescita common shares and the Post-Arrangement Nuvo common shares during the five-trading days during the period from March 7, 2016 to March 11, 2016. As a result of the Arrangement, on March 1, 2016, 11,487,184 Nuvo common shares, with a stated capital of $236.5 million, were cancelled and 11,487,184 Nuvo common shares, with a stated capital of $184.9 million, were issued. The amount of Nuvo’s net investment in Crescita at the effective date of the Arrangement of $19.4 million was deducted from Nuvo’s deficit and the unrealized income on translation of foreign operations transferred to Crescita in the amount of $1.1 million was deducted from Nuvo’s AOCI (loss). Private Placement On March 31, 2014, the Company completed a non-brokered private placement (Private Placement), pursuant to which an aggregate of 1,390,000 units of the Company were issued at a price of $2.25 per unit for gross proceeds of $3.1 million ($2.9 million net of issuance costs). Each unit consisted of one common share of the Company and one-half of one common share purchase warrant of the Company. The Company issued 695,000 common share purchase warrants (Private Placement Warrants). A Private Placement Warrant entitled the holder to purchase one common share of Nuvo at a price of $3.00 for a 24-month period. In connection with the Private Placement, the Company issued 78,233 broker warrants at a price of $2.54 per unit (Broker Warrants). Each Broker Warrant unit entitled the holder to purchase one common share of the Company at a price of $2.54 and included one half of one Private Placement Warrant. The Private Placement Warrants were subject to an acceleration feature where the Company, at its option, could force the exercise of the Private Placement Warrants if the ten-day volume weighted share price for the Company’s common shares was equal to, or exceeded, $3.50 on the TSX at any time during the warrant term. If the acceleration feature was used, any Private Placement Warrants that were not exercised during this period expired. The Company exercised its acceleration feature on November 30, 2015 and accelerated the expiry date of the outstanding warrants to January 15, 2016. During the three months ended March 31, 2016, 4,200 Broker Warrants and 49,044 Private Placement Warrants, inclusive of 2,100 Private Placement Warrants that were issued on exercise of the Broker Warrants, were exercised for proceeds of $0.2 million and 12,252 Private Placement Warrants expired. 10. STOCK-BASED COMPENSATION AND OTHER STOCK-BASED PAYMENTS The Company has four stock-based compensation plans: the Share Option Plan, the Share Purchase Plan and the Share Bonus Plan, each a component of the Company’s Share Incentive Plan and the SARs Plan. As part of the Arrangement, the DSU Plan for non-employee directors and the DSU Plan for employees were terminated and settled in shares on March 1, 2016. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Share Incentive Plan Under the Company’s Share Incentive Plan, there are three sub plans: (i) the Share Option Plan, (ii) the Share Purchase Plan, and (iii) the Share Bonus Plan. On May 11, 2017, shareholders of Nuvo approved a resolution affirming, ratifying and approving the Share Incentive Plan and approving all of the unallocated common shares issuable pursuant to the Share Incentive Plan. The TSX requires that the Company’s Share Incentive Plan, along with any unallocated options, rights or other entitlements, receive shareholder approval at the Company’s annual meeting every three years. The maximum number of common shares that will be reserved for issuance under the Share Incentive Plan shall be 15% of the total number of common shares outstanding from time-to-time. The allocation of such maximum percentage among the three sub plans comprising the Share Incentive Plan shall be determined by the Board of Directors (or a committee thereof) from time-to-time (provided that the maximum number of common shares that may be issued under the Share Bonus Plan shall not exceed a fixed number of common shares equal to 3% of the number of common shares outstanding immediately following the Arrangement, which was 344,615). As at December 31, 2017, the number of common shares available for issuance under the Share Incentive Plan was 703,164. Share Option Plan Under the Share Option Plan, the Company may grant options to purchase common shares to officers, directors, employees or consultants of the Company or its affiliates. Options issued under the Share Option Plan are granted for a term not exceeding ten years from the date of grant. All options issued to-date have a life of ten years. In general, options have vested either immediately upon grant or over a period of one to four years or upon the achievement of certain performance-related measures or milestones. Under the provisions of the Share Option Plan, the exercise price of all stock options shall not be less than the closing price of the common shares on the last trading date immediately preceding the grant date of the option. The following is a schedule of the options outstanding as at: Balance, December 31, 2015 Cancelled on Reorganization Issued on Reorganization Granted Exercised Forfeited Expired Balance, December 31, 2016 Granted Exercised Forfeited Expired Balance, December 31, 2017 Number of Options 000s 751 (751) 751 207 (53) (46) (10) 849 369 (5) (18) (166) 1,029 Range of Exercise Price $ 1.96 - 24.05 1.96 - 24.05 1.53 - 18.80 5.42 1.53 - 6.35 2.65 - 5.42 6.35 - 18.80 1.53 - 12.70 3.80 - 5.75 1.53 4.32 - 6.35 6.86 - 12.70 1.53 - 12.70 Weighted Average Exercise Price $ 6.18 6.18 4.83 5.42 3.48 4.41 11.35 5.01 5.50 1.53 5.18 7.01 4.88 The fair value of each tranche is measured at the date of grant using the Black-Scholes option pricing model. Options are valued with a calculated forfeiture rate of 7.0% [December 31, 2016 - 7.0%], and the remaining model inputs for options granted during the year ended December 31, 2017 were as follows: Options (000s) 314 22 33 Grant Date March 7, 2017 May 19, 2017 November 17, 2017 Share Price $ 5.75 4.45 3.80 Exercise Price $ 5.75 4.45 3.80 Risk-free Interest Rate % 1.02 - 1.42 0.94 - 1.27 1.90 Expected Life (years) 5 - 7 5 - 6 5 - 7 Volatility Factor 67 - 71 66 - 70 65 - 68 Fair Values $ 3.28 - 3.66 2.46 - 2.76 2.13 - 2.42 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) The following table summarizes the outstanding and exercisable options held by directors, officers, employees and consultants as at December 31, 2017: Exercise Price Range $ 1.53 - 4.45 5.08 - 5.75 6.35 - 11.18 Number of Options (000s) 354 612 63 1,029 Outstanding Remaining Contractual Life (years) 6.39 7.83 1.88 6.97 Weighted Average Exercise Price $ 2.89 5.52 9.85 4.88 Exercisable Vested Options (000s) 262 190 63 515 Weighted Average Exercise Price $ 2.71 5.21 9.85 4.47 Share Appreciation Rights Plan On October 30, 2013, the Company established the SARs Plan for directors, officers, employees or designated affiliates to provide incentive compensation based on the appreciation in value of the Company’s common shares. Under the SARs Plan, participants receive, upon vesting, a cash amount equal to the difference between the SARs fair market value and the grant price value, also known as the intrinsic value. Fair market value is determined by the closing price of the Company’s common shares on the TSX on the day preceding the exercise date. SARs vest in tranches prescribed at the grant date and each tranche is considered a separate award with its own vesting period and grant date fair value. Until SARs vest, compensation expense is measured based on the fair value of the SARs at the end of each reporting period using the Black-Scholes option pricing model. The fair value of the liability is remeasured at the end of each reporting date and adjusted at the settlement date when the intrinsic value is realized. The SARs accrual is included in accounts payable and accrued liabilities. The fair values of each tranche issued and outstanding in the period were measured as at December 31, 2017 using the Black-Scholes option pricing model with the following inputs: SARs (000s) 67 104 Grant Date April 4, 2014 January 7, 2015 Exercise Price $ 2.65 5.63 Risk-free Interest Rate % 1.41 1.41 Expected Life (years) 1 1 Volatility Factor % 34 34 Fair Values $ 1.05 0 - 0.08 The following table summarizes the outstanding SARs and related accrual as at December 31, 2017: Balance, December 31, 2015 Vested Adjustment to market value at Reorganization Cancelled on Reorganization Issued on Reorganization Cancelled Termination Adjustment to market value Balance, December 31, 2016 Vested Adjustment to market value Balance, December 31, 2017(i) Number of SARs 000s 788 (293) - (495) 495 (20) (58) - 417 (246) - 171 Fair Values $ 0.00 - 3.45 0.00 - 3.36 - 0.72 - 4.48 0.56 - 3.50 1.86 - 5.91 1.73 - 5.91 - 0.02 - 4.21 0.00 - 4.21 - 0.00 - 4.21 Accrual $ 1,328 (654) 255 (929) 726 (73) (248) 626 1,031 (738) (219) 74 (i) On January 1, 2018, 119,000 SARs vested and $70 was paid to SARs Plan participants. Deferred Share Unit Plan Under the DSU Plan, non-employee directors could allot and elect to receive a portion of their annual retainers and other Board-related compensation in the form of DSUs. One DSU had a cash value equal to the market price of Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) one of the Company’s common shares and the number of DSUs issued to a director’s DSU account for any payment was determined using the five-day VWAP of the Company’s common shares immediately preceding the payment date. Under the employee DSU Plan, employees could elect to have a portion of their quarterly earnings issued in units of the DSU Plan. Consistent with non-employee directors, one DSU had a cash value equal to the market price of one of the Company’s common shares. The number of units to be credited to an employee was calculated by dividing the elected portion of the compensation payable to the employee by the five-day VWAP of the Company’s common shares immediately preceding the close of each quarter. Upon execution of the Reorganization on March 1, 2016, all outstanding DSUs for directors and employees were settled in shares of Nuvo net of the cash tax obligation that was paid by Nuvo. Nuvo settled the DSU Plan by issuing 288,226 common shares to settle 451,111 outstanding DSUs. The shares issued were restricted from trading for twelve months. The common shares were issued net of the cash tax obligation that was payable by the Company. The DSU Plan for employees was terminated March 1, 2016. There was no DSU accrual as at December 31, 2017 [December 31, 2016 - $nil]. Summary of Stock-based Compensation Stock-based compensation from continuing operations is as follows: Stock option compensation expense under the Share Option Plan Shares issued to employees under the Share Purchase Plan DSUs - issued for settlement of directors’ fees DSUs - adjustment to market value SARs compensation expense Stock-based compensation expense(i) Recorded in the Consolidated Statements of Income and Comprehensive Income as follows: Cost of goods sold Research and development expenses General and administrative expenses Year ended December 31, 2017 $ 705 - - - (219) 486 Year ended December 31, 2016 $ 202 18 120 384 659 1,383 29 - 457 486 17 12 1,354 1,383 (i) During the year ended December 31, 2017, the Company’s discontinued operations included $nil of stock-based compensation [December 31, 2016 - $288]. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 11. NET INCOME (LOSS) PER COMMON SHARE Income (loss) per share is computed as follows: Basic income (loss) per share: Net income Average number of shares outstanding during the year Basic income per share Basic income per share from continuing operations Basic loss per share from discontinued operations Net income, assuming dilution Net income from continuing operations, assuming dilution Average number of shares outstanding during the year Dilutive effect of: Stock options Warrants Deferred share units Share appreciation rights Weighted average common shares outstanding, assuming dilution Diluted income per share Diluted income per share from continuing operations Diluted loss per share from discontinued operations Year ended December 31, 2017 $ Year ended December 31, 2016 $ 1,581 11,550 0.14 0.14 - 1,455 1,455 11,550 143 - - 30 11,723 0.12 0.12 - 4,229 11,455 0.37 0.65 (0.28) 4,194 7,374 11,455 235 1 9 11 11,711 0.36 0.63 (0.28) The following table presents the maximum number of shares that would be outstanding if all dilutive and potentially dilutive instruments were exercised or converted as at: Common shares issued and outstanding Stock options outstanding (Note 10) Share appreciation rights outstanding (Note 10) December 31, 2017 000s December 31, 2016 000s 11,551 1,029 171 12,751 11,546 849 417 12,812 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 12. EXPENSES BY NATURE The Consolidated Statements of Income and Comprehensive Income include the following expenses by nature: (a) Employee costs from continuing operations: Short-term employee wages, bonuses and benefits Share-based payments Total employee costs Included in: Cost of goods sold Research and development expenses General and administrative expenses Total employee costs (b) Depreciation and amortization from continuing operations: Cost of goods sold Research and development expenses General and administrative expenses Total depreciation and amortization (i) Year ended December 31, 2017 $ 5,667 396 6,063 Year ended December 31, 2016 $ 5,320 983 6,303 2,831 - 3,232 6,063 3,710 25 2,568 6,303 Year ended December 31, 2017 $ Year ended December 31, 2016 $ 251 - 7 258 197 28 - 225 (i) During the year ended December 31, 2017, the Company’s discontinued operations included $nil of depreciation expense [December 31, 2016 - $8]. 13. NET CHANGE IN NON-CASH WORKING CAPITAL The net change in non-cash working capital consists of: Accounts receivable Inventories Other current assets Accounts payable and accrued liabilities Net change in non-cash working capital Year ended December 31, 2017 $ 514 1,300 1,063 (1,219) Year ended December 31, 2016 $ 2,775 (1,847) (213) (3,208) 1,658 (2,493) Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 14. INCOME TAXES Deferred Tax Assets and Liabilities Deferred income taxes represent the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following represents deferred tax assets that have not been recognized in these Consolidated Financial Statements: Canadian Scientific Research and Experimental Development expenditure pool carryforward Investment tax credits Tax basis of PP&E and intangible assets in excess of accounting value Financing costs, deferred revenue and other Deferred tax assets not recognized Year ended December 31, 2017 Year ended December 31, 2016 $ - 1,573 2,275 9 3,857 $ 358 1,993 2,479 19 4,849 A reconciliation between the Company’s statutory and effective tax rates is presented below: Statutory rate Items not deducted for tax Revaluation of deferred taxes as a result of enacted tax rate changes and other Utilization of previously unrecognized deferred tax assets Other Year ended December 31, 2017 Year ended December 31, 2016 % 26.7 8.6 - (35.3) - - % 26.8 8.2 0.6 (39.0) 3.4 - The Company has approximately $nil [December 31, 2016 - $1.3 million] of Canadian Scientific Research and Experimental Development (SR&ED) expenditures for federal tax purposes that are available to reduce taxable income in future years and have an unlimited carryforward period, the benefit of which has not been reflected in these Consolidated Financial Statements. SR&ED expenditures are subject to audit by the tax authorities and accordingly, these amounts may vary. The Company has net capital losses of $48.1 million in Canada available to offset net taxable capital gains in future years which have not been recognized. Government Assistance A portion of the Company’s research and development (R&D) expenditures are eligible for Canadian federal investment tax credits that it may carry forward to offset any future Canadian federal income taxes payable as follows: Year of Credit December 31, 2006 December 31, 2007 December 31, 2008 December 31, 2009 December 31, 2010 December 31, 2011 December 31, 2012 December 31, 2015 Amount $ 298 335 225 142 395 208 43 494 2,140 Year of Expiry 2026 2027 2028 2029 2030 2031 2032 2035 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) The benefits of these non-refundable Canadian federal investment tax credits have not been recognized in these Consolidated Financial Statements. 15. DISCONTINUED OPERATIONS On March 1, 2016, the Company completed the Reorganization of Nuvo into two separate publicly traded companies, Nuvo and Crescita, each initially owned 100% by Nuvo’s shareholders. With the completion of the Reorganization on March 1, 2016, operating results have been restated to reflect Crescita as a discontinued operation. Accordingly, Crescita is no longer presented in Note 19, Segmented Information. The following table presents the effect of the discontinued operations in the Consolidated Statements of Income and Comprehensive Income: (In thousands, except per share figures) REVENUE Product sales Royalties Total revenue OPERATING EXPENSES Cost of goods sold Research and development expenses General and administrative expenses Interest expense Total operating expenses OTHER INCOME Foreign currency gain NET LOSS FROM DISCONTINUED OPERATIONS Net loss from discontinued operations per common share - basic and diluted Average number of common shares outstanding - basic - diluted Year ended December 31, 2017 $ Year ended December 31, 2016 $ - - - - - - - - - - - - - 45 14 59 96 648 2,498 5 3,247 (8) (3,180) (0.28) 11,455 11,711 The following table presents the effect of the discontinued operations in the Consolidated Statements of Cash Flows: Cash used in operating activities Cash provided by investing activities Cash provided by financing activities Net cash inflow Year ended December 31, 2017 $ - - - - Year ended December 31, 2016 $ (5,203) 4,801 34,963 34,561 Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 16. COMMITMENTS The Company has minimum future rental payments under operating leases for the twelve months ending December 31 as follows: 2018 2019 2020 and thereafter Operating Leases $ 162 198 828 1,188 For the year ended December 31, 2017, payments under operating leases totalled $0.2 million [December 31, 2016 - $46]. Under the terms of the Pennsaid 2% U.S. Asset Sale with Horizon, Nuvo is contractually obligated to manufacture Pennsaid 2% for the U.S. market to December 2029 and, unless terminated, the supply agreement will renew for successive two-year terms, thereafter. The agreement provides for tiered pricing based on volumes of product shipped. The Company is also required to maintain certain raw material inventory levels. The Company has additional long-term supply contracts where the Company is contractually obligated to manufacture Pennsaid 2% and Pennsaid for its customers. The Company has a long-term supply agreement with a third-party manufacturer for the supply of dimethyl sulfoxide, one of its key raw materials in Pennsaid 2% and Pennsaid, which expires in December 2022. The agreement automatically renews for successive three-year terms, unless terminated in writing by either party at least 12 months prior to the expiration of the current term. The agreement requires the Company to purchase 100% of its dimethyl sulfoxide requirements from the third party at specified pricing, but does not contain any minimum purchase commitments. Under certain licensing agreements, the Company is required to make royalty payments to two companies for a combined 2.5% of annual net sales of the HLT Patch. Guarantees The Company periodically enters into service, licensing, distribution or supply agreements with third parties that include indemnification provisions that are customary in the industry. These guarantees generally require the Company to compensate the other party for certain damages and costs incurred as a result of third-party intellectual property claims or damages arising from these transactions. In some cases, the maximum potential amount of future payments that could be required under these indemnification provisions is unlimited. These indemnification provisions generally survive termination of the underlying agreements. The nature of the intellectual property indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay. Historically, the Company has not made any indemnification payments under such agreements and no amount has been accrued in these Consolidated Financial Statements with respect to these indemnification obligations. 17. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT IFRS 7 - Financial Instruments: Disclosures requires disclosure of a three-level hierarchy that reflects the significance of the inputs used in making fair value measurements. Fair values of assets and liabilities included in Level 1 are determined by reference to quoted prices in active markets for identical assets and liabilities. Assets and liabilities in Level 2 include those where valuations are determined using inputs other than quoted prices for which all significant outputs are observable, either directly or indirectly. Level 3 valuations are those based on inputs that are unobservable and significant to the overall fair value measurement. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes to the ability to observe valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. The Company did not have any transfer of assets and liabilities between Level 1, Level 2 and Level 3 of the fair value hierarchy during the year ended December 31, 2017. The Company has determined the estimated fair values of its financial instruments based on appropriate valuation methodologies. However, considerable judgment is required to develop these estimates. Accordingly, these estimated values are not necessarily indicative of the amounts the Company could realize in a current market exchange. The estimated fair value amounts can be materially affected by the use of different assumptions or methodologies. The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis as at December 31, 2017: Assets: Short-term investments Total assets Liabilities: SARs Contingent and variable consideration related to the Resultz acquisition (Note 4) Total liabilities Total $ 2,000 2,000 74 1,626 1,700 Using Quoted Prices in Active Markets for Identical Assets (Level 1) $ Using Significant Other Unobservable Inputs (Level 2) $ Using Significant Unobservable Inputs (Level 3) $ - - - - - 2,000 2,000 74 - 74 - - - 1,626 1,626 The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis as at December 31, 2016: Assets: Short-term investments Total assets Liabilities: SARs Total liabilities Total $ 8,000 8,000 1,031 1,031 Using Quoted Prices in Active Markets for Identical Assets (Level 1) $ Using Significant Other Unobservable Inputs (Level 2) $ Using Significant Unobservable Inputs (Level 3) $ - - - - 8,000 8,000 1,031 1,031 - - - - Level 2 assets include guaranteed investment certificates held by the Company that are valued at fair value and the fair value approximates the carrying value due to the short-term nature. Level 2 liabilities include obligations of the Company for the SARs Plan described in Note 10, Stock-based Compensation and Other Stock-based Payments. The fair values of each tranche of SARs issued and outstanding are revalued at each reporting period using the Black-Scholes option pricing model. The Company accrued $0.1 million for SARs as at December 31, 2017 [December 31, 2016 - $1.0 million]. Level 3 liabilities include the fair value of contingent and variable consideration related to the acquisition of the ex- U.S. rights to Resultz. The fair value is estimated using a present value technique described in Note 4, Acquisition of Resultz Product and Intellectual Property Rights. The fair value of $1.6 million is estimated by probability weighting the estimated future cash outflows, adjusting for risk and discounting at rates ranging from 20% - 30%. The probability-weighted cash outflows reflect management’s estimates of a 0% - 25% probability that various milestones will be achieved. For the variable consideration, the estimated future cash flows are not probability Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) weighted as the consideration is based on a percentage of net sales in certain markets, not on specific milestones. The discount rate used is based on the Company’s risk-adjusted estimated weighted average cost of capital at the reporting date. The effects on the fair value of risk and uncertainty in the future cash flows are dealt with by adjusting the estimated cash flows rather than adjusting the discount rate. The contingent consideration is driven by the anticipated sales volumes of Resultz in certain markets. A 10% decrease in the projected sales volumes of Resultz in these markets would decrease the fair value of the contingent consideration liability by $0.4 million. Rates currently available to the Company for long-term obligations, with similar terms and remaining maturities, have been used to estimate the fair value of the finance lease and other obligations. These fair values approximate the carrying values for all instruments. Risk Factors The following is a discussion of liquidity risk, credit risk and market risk and related mitigation strategies that have been identified. This is not an exhaustive list of all risks nor will the mitigation strategies eliminate all risks listed. Liquidity Risk While the Company had $8.4 million in cash and cash equivalents and $2.0 million in short-term investments as at December 31, 2017, it was dependent on a single customer for substantially all of its revenue. During the year ended December 31, 2017, the Company earned 87% [December 31, 2016 - 92%] of its product revenue from a single customer, Horizon. The Company earns product revenue from Horizon pursuant to a long-term, exclusive supply agreement, as well as contract service revenue. The loss of this customer would have a material adverse effect on the Company’s revenue, operating results and cash flows. The Company continues to seek business opportunities to diversify its customer base in order to help mitigate this concentration risk. On December 29, 2017, the Company acquired the global, ex-U.S. product and intellectual property rights to Resultz from Piedmont which includes existing royalty streams in the Royalty Markets (See Note 4, Acquisition of Resultz Product and Intellectual Property Rights). The benefits of the acquisition include expanding the Company’s portfolio of commercial products and Resultz can be produced at Nuvo’s Varennes, Québec manufacturing facility. The Company has contractual obligations related to accounts payable and accrued liabilities, purchase commitments and other obligations of $3.3 million that are due in less than a year and $1.0 million of contractual obligations that are payable from 2019 to 2023. Credit Risk The Company’s cash, cash equivalents and short-term investments subject the Company to a concentration of credit risk. As at December 31, 2017, the Company had $8.4 million invested with two financial institutions in various bank accounts. These financial institutions are major Canadian banks, which the Company believes lessens the degree of credit risk. Additionally, the Company maintains $2.0 million in short-term investments with a creditworthy Canadian insurance company. The Company, in the normal course of business, is exposed to credit risk from its global customers, most of whom are in the pharmaceutical industry. The accounts receivable are subject to normal industry risks in each geographic region in which the Company operates. The Company attempts to manage these risks prior to the signing of distribution or licensing agreements by dealing with creditworthy customers; however, due to the limited number of potential customers in each market, this is not always possible. In addition, a customer’s creditworthiness may change, subsequent to becoming a licensee or distributor, and the terms and conditions in the agreement may prevent the Company from seeking new licensees or distributors in these territories during the term of the agreement. The Company has not recognized any bad debts in comprehensive income for the year ended December 31, 2017 [December 31, 2016 - $nil]. As at December 31, 2017, the Company’s largest customer represented 76% [December 31, 2016 - 73%] of accounts receivable. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Pursuant to their collective terms, accounts receivable were aged as follows: Current 0 - 30 days past due 31 - 60 days past due Over 60 days past due December 31, 2017 $ 1,731 128 7 9 1,875 December 31, 2016 $ 2,159 11 216 - 2,386 Interest Rate Risk All finance lease obligations are at fixed interest rates. Currency Risk The Company operates globally, which gives rise to a risk that income and cash flows may be adversely affected by fluctuations in foreign currency exchange rates. The Company is primarily exposed to the U.S. dollar and euro, but also transacts in other foreign currencies. The Company currently does not use financial instruments to hedge these risks. The significant balances in foreign currencies were as follows: Cash Accounts receivable Other current assets Accounts payable and accrued liabilities Euros U.S. Dollars December 31, 2017 € December 31, 2016 € December 31, 2017 $ December 31, 2016 $ 621 - - (32) 589 242 - - (305) (63) 1,290 1,378 - (751) 1,917 3,929 1,636 - (289) 5,276 Based on the aforementioned net exposure as at December 31, 2017, and assuming that all other variables remain constant, a 10% appreciation or depreciation of the Canadian dollar against the U.S. dollar would have an effect of $0.2 million on total comprehensive income and a 10% appreciation or depreciation of the Canadian dollar against the euro would have an effect of $0.1 million on total comprehensive income. In terms of the euro, the Company has two significant exposures: its euro denominated-cash held in its Canadian operations and sales of Pennsaid by the Canadian operations to European distributors. In terms of the U.S. dollar, the Company has three significant exposures: its U.S. dollar-denominated cash held in its Canadian operations, the cost of purchasing raw materials either priced in U.S. dollars or sourced from U.S. suppliers that are needed to produce Pennsaid 2%, Pennsaid or other products at the Canadian manufacturing facility and revenue generated in U.S. dollars from agreements with Horizon, Galen and Eurocept. For the year ended December 31, 2017, the Company did not hold an investment in active foreign operations. The Company does not currently hedge its euro cash flows. Sales to European distributors for Pennsaid are primarily contracted in euros. The Company receives payments from the distributors in its euro bank accounts and uses these funds to pay euro denominated expenditures. Periodically, the Company reviews the amount of euros held, and if they are excessive compared to the Company’s projected future euro cash flows, they may be converted into U.S. or Canadian dollars. If the amount of euros held is insufficient, the Company may convert a portion of other currencies into euros. The Company does not currently hedge its U.S. dollar cash flows. The Company’s U.S. expenditures are funded using the Company’s U.S. dollar-denominated cash and payments received under the terms of the agreements with Horizon, Galen and Eurocept. Periodically, the Company reviews its projected future U.S. dollar cash flows and if the U.S. dollars held are insufficient, the Company may convert a portion of its other currencies into U.S. dollars. If the amount of U.S. dollars held is excessive, they may be converted into Canadian dollars or other currencies as needed for the Company’s other operations. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) 18. CAPITAL MANAGEMENT The Company currently defines its capital to include its cash, short-term investments and shareholders’ equity excluding AOCI. The Company’s objectives when managing capital are: (a) to allow the Company to respond to changes in economic and marketplace conditions; (b) to give shareholders sustained growth in shareholder value by increasing equity; and (c) to maintain a flexible capital structure that optimizes the cost of capital at acceptable levels of risk. In the past, the Company has financed its business primarily through its operations, the net proceeds received from the sale of common shares and warrants, issuance of secured debt and convertible debentures, finance lease obligations and investment income earned on cash balances and short-term investments. The Company continues to manage its capital structure and will maintain or adjust its capital structure to facilitate the execution of the Company’s objectives or in light of changes in the economic environment. As a result, to secure the capital necessary to pursue its objectives and fund ongoing operations, the Company may need to raise additional funds and make adjustments to its capital structure by raising capital through equity financings, utilizing leverage in the form of third-party debt, entering into distribution and licensing agreements or realizing proceeds from the disposition of its investments. There can be no assurance, especially considering the economic environment, that additional financing would be available on acceptable terms, or at all, when and if required. If adequate funds are not available when required, the Company may have to substantially reduce or eliminate planned expenditures. 19. SEGMENTED INFORMATION Segments IFRS 8 - Operating Segments requires operating segments to be determined based on internal reports that are regularly reviewed by the chief operating decision maker for the purpose of allocating resources to the segment and to assessing its performance. Prior to the fourth quarter of 2015, the Company reported two operating segments: the Topical Products and Technology Group and the Immunology Group. In the fourth quarter of 2015, the Company changed its operating segments and reported Nuvo and Crescita as its two operating segments pending the then proposed Reorganization. With the completion of the Reorganization on March 1, 2016, operating results have been restated to reflect Crescita as a discontinued operation. Due to the timing of the Resultz acquisition as disclosed in Note 4, Acquisition of Resultz Product and Intellectual Property Rights, for the year ended December 31, 2017, the Company continued to operate as one segment. Geographic Information The Company’s revenue from continuing operations was derived from sales to, and licensing revenue derived from, external customers located in the following geographic areas: United States Europe Canada Other Year ended December 31, 2017 $ 15,084 1,875 551 13 Year ended December 31, 2016 $ 24,528 1,712 799 - 17,523 27,039 As at December 31, 2017, all of the Company’s PP&E was located in Canada. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Significant Customers For the year ended December 31, 2017, the Company’s four largest customers generating product sales represented 98% [December 31, 2016 - 98%] of total product sales and the Company’s largest customer represented 87% [December 31, 2016 - 92%] of total product sales. 20. RELATED PARTY TRANSACTIONS Crescita Therapeutics Inc. Subsequent to the Reorganization, Nuvo and Crescita were related parties due to shared key management personnel. Effective March 1, 2016, Nuvo and Crescita entered into a reciprocal transitional services agreement with a term of 18 months. Under the transitional services agreement (a) Nuvo provided Crescita corporate-level employee services, quality assurance support and facility rental, and (b) Crescita provided Nuvo corporate-level employee services, R&D, legal support and facility and equipment rental. As a result of the restructuring of key management personnel, Nuvo and Crescita are no longer related parties. For the year ended December 31, 2016, services provided to Crescita were $0.3 million and services received from Crescita were $0.4 million. Key Management Compensation Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of the Company, including directors. Key management includes five executive officers and five non-employee directors. Compensation for the Company’s key management personnel was as follows: Short-term wages, bonuses and benefits (i) Share-based payments Total key management compensation Included in: Research and development expenses General and administrative expenses Total key management compensation Year ended December 31, 2017 $ Year ended December 31, 2016 $ 2,133 457 2,590 - 2,590 2,590 1,772 968 2,740 11 2,729 2,740 (i) For the year ended December 31, 2017, certain officers of the Company were assessed on the achievement of corporate objectives. The Company expects the achievement of these targets to be determined during the first quarter of 2018. 21. OPERATING CREDIT FACILITY In September 2017, the Company secured a $6.0 million operating revolving credit facility (Facility) with the Royal Bank of Canada (RBC) that will bear interest at a low, single-digit premium to RBC’s prime rate or RBC’s U.S. base rate. The Facility is a standby facility that can be drawn by Nuvo for working capital requirements and general corporate purposes in Canadian dollar-denominated loans and U.S. dollar-denominated loans. Drawings on the Facility are limited to a percentage of the Company’s then outstanding accounts receivable and inventory. The Company has the right to repay any balance owing under the Facility at any time without bonus interest or penalty. Loans drawn on the Facility are secured by a first charge in favour of RBC over the Company’s assets. As at December 31, 2017, the Company had not drawn any amount of the Facility. 22. SUBSEQUENT EVENT Resultz U.S. Asset Purchase On January 12, 2018, the Company’s wholly owned subsidiary, Nuvo Ireland acquired control of the U.S. product and intellectual property rights to Resultz (the U.S. Patent). Resultz was cleared as a Class 1 medical device by the FDA in May 2017 and has not yet been commercially launched in the U.S. As the product has not yet launched Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) in the U.S. market, the transaction did not include any royalty streams. Further, Nuvo has not assumed a licensee agreement to sell and distribute Resultz as part of this transaction. The transaction will be accounted for as an asset acquisition. The cost of the U.S. Patent was US$1.5 million ($1.9 million), settled from cash on hand. The purchase agreement included variable consideration related to future earnings associated with the U.S. Patent during the period from 2018 to 2034 and will be expensed as incurred. Nuvo Pharmaceuticals Inc. ▪ Consolidated Financial Statements (audited) Corporate Information HEAD OFFICE 6733 Mississauga Road, Suite 610 Mississauga, Ontario, Canada L5N 6J5 Tel. (905) 673-6980 Fax. (905) 673-1842 Email: info@nuvopharm.com Website: www.nuvopharmaceuticals.com INVESTOR RELATIONS Email: ir@nuvopharm.com AUDITORS Ernst & Young LLP Chartered Professional Accountants Licensed Public Accountants Toronto, Canada LEGAL COUNSEL Goodmans LLP Toronto, Canada STOCK EXCHANGE LISTING The Toronto Stock Exchange Symbol: NRI OTCQX Symbol: NRIFF TRANSFER AGENT/REGISTRAR Common Shares AST Trust Company (Canada) P.O. Box 700, Station B Montreal, QC H3B 3K3 Canada Telephone: 1-800-387-0825 or outside Canada and U.S. 416-682-3860 Fax: 1-888-249-6189 or outside Canada and U.S. 514-985-8843 Email: inquiries@astfinancial.com Website: www.astfinancial.com/ca CORPORATE GOVERNANCE A statement of the Company’s current corporate governance practices is contained in the management information circular and proxy statement for the May 10, 2018 Annual and Special Meeting of Shareholders. The Company’s website www.nuvopharmaceuticals.com contains the Company’s corporate governance documents including Articles and By-laws, Committee Charters and Key Position Descriptions and Corporate Policies and Practices. Board of Directors and Executive Officers John C. London, LLB, LLM Executive Chairman Daniel N. Chicoine, BComm, CPA, CA Director David A. Copeland, BMath, CPA, CA Lead Director Chair of the Audit Committee Anthony E. Dobranowski, BSc, MBA, CPA, CA Director Jesse F. Ledger, BBA President & Chief Executive Officer Jacques Messier, DVM, MBA Director Chair of the Compensation, Corporate Governance & Nominating Committee Robert Harris Director Chair of the Transaction Committee Mary-Jane E. Burkett, CPA, CA, HBA Vice President & Chief Financial Officer (maternity leave) Katina K. Loucaides, MSc, LLB Vice President, Secretary & General Counsel N. Nicole Rusaw, CPA, CA, HBACC Interim Chief Financial Officer 

Continue reading text version or see original annual report in PDF format above